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ATestonDeterminantsofChina’sDemandforInternationalReservesAthesispresentedtothefacultyoftheCollegeofArtsandSciencesofOhioUniversityInpartialfulfillmentoftherequirementsforthedegreeMasterofArtsYiHeNovember2009©2009.YiHe.AllRightsReserved.2ThisthesistitledATestonDeterminantsofChina’sDemandforInternationalReservesbyYIHEhasbeenapprovedfortheDepartmentofEconomicsandtheCollegeofArtsandSciencesbyKhosrowDoroodianProfessorofEconomicsChulhoJungProfessorofEconomicsBolongCaoAssistantProfessorofEconomicsBenjaminM.OglesDean,CollegeofArtsandSciences3ABSTRACTHe,Yi,M.A.,November2009,EconomicsATestonDeterminantsofChina’sDemandforInternationalReserves.(40pp.)DirectorsofThesis:KhosrowDoroodian,ChulhoJung,BolongCao.Byemployingquarterlydatafromtheperiodof2001through2008,thisthesistriestotesttheeffectoffourdeterminantsonChina’sdemandforinternationalreserves.Thefourdeterminantsareinternationalreservesvariability,GDP,averagepropensitytoimportandinterestratespread.EmpiricalresultsshowsChina’sholdingofinternationalreservesexperienceseconomiesofscale.Ofthesefourdeterminants,internationalreservesvariabilityhasthemostsignificantpositiveimpactonthedemandforinternationalreserves.GDPhasthesecondlargestpositiveimpactonthedemandforinternationalreserves,andtheaveragepropensitytoimporthasmuchlesspositiveimpactthantheformertwo.Asmeasuredbyinterestratespread,opportunitycostofholdingreserveshasasmallnegativeeffectonChina’sdemandforinternationalreserves.IfChinesemonetaryauthoritydoesnotwantthereservestogrowfurther,constraintsmustbeputonthedeterminantswhichhaveapositiveeffectondemandforreserves.While,asforopportunitycost,nosubstantialadjustmentsneedtobeundertakenifinterestratespreadincreases.4Approved:KhosrowDoroodianProfessorofEconomicsChulhoJungProfessorofEconomicsBolongCaoAssistantProfessorofEconomics5DEDICATIONIwouldliketodedicatethispapertomymotherXueqinLiu,fatherNaiqiHeandthe60thbirthdayofP.R.China6TABLEOFCONTENTSPageAbstract..............................................................................................................................3 Dedication..........................................................................................................................5 ListofFigures....................................................................................................................7 1.Introduction...................................................................................................................8 1.1Background:AccumulationofTrillionDollarReserves.....................................8 1.2LiteratureReview.................................................................................................12 2TheModel.....................................................................................................................15 3TheData........................................................................................................................18 4Empiricalresults..........................................................................................................21 5Conclusion....................................................................................................................26 Appendix1:GDPandGNIDifference.........................................................................29 Appendix2:UnitRootforlogr......................................................................................30 Appendix3:UnitRootforlogy......................................................................................31 Appendix4:UnitRootforlogvr....................................................................................32 Appendix5:UnitRootforlogm....................................................................................33 Appendix6:UnitRootforlogi......................................................................................34 Appendix7:JohansenCointegrationTest...................................................................35 Appendix8:LMTest......................................................................................................39 Appendix9:RegressionResult......................................................................................40 7LISTOFFIGURESPageFigure1:VolumeofForeignExchangeReserves............................................................8Figure2:StaticForecastoftheEstimatedFunction.......................................................22Figure3:ActualReserveLevelandStaticForecastReserveLevel...............................2381.INTRODUCTION1.1Background:AccumulationofTrillionDollarReservesSincetheyear1978whenChinaopeneditsdoortotheworld,internationalreserveshasbecomeimportantintradingwithothercountries,especiallywhenChinaturneditselfintoabigexporterandimporterintheworldmarket.Forthelast31years,thegrowthhistoryofChina’sinternationalreservescanbedividedroughlyintofourperiods:smallscalegrowthperiod(1978-1993);moderategrowthperiod(1994-1997);slowgrowthperiod(1998-2000);fastgrowthperiod(2001-2008).Figure1:VolumeofForeignexchanger