Ann Oper Res DOI 10.1007/s10479-006-0124-6 Strategic foreign reserves risk management: Analytical framework Stijn Claessens · Jerome Kreuser C  Springer Science + Business Media, LLC 2006 Abstract We present an analytical framework for active foreign exchange reserves man- agement that integrates risk-return objectives with macroeconomic, macro-prudential and sovereign debt management concerns. Our framework allows for very general objective functions, does not restrict the class of eligible stochastic processes or limit the investment universe, and can incorporate many types of macroeconomic concerns. It incorporates sev- eral kinds of risk constraints in order to obtain benchmarks satisfying possible central bank requirements of safety, liquidity, returns, and stability. Feedback between outcomes and de- cisions is easy using tools that reshape distributions and functions of the outcomes. And the model can be run on a PC-based platform. We apply the framework to several common reserves management problems focusing especially on the formulation of model equations, generation of trees and estimation of density functions of outcomes. We compare our ap- proach to those used by many central banks and discuss advantages to our approach. Keywords Reserves management . ALM . Asset/liability . Dynamic stochastic optimization Central bank foreign exchange reserves risk management concerns balancing many objec- tives and issues, from broad macro-economy policy objectives, such as monetary policy and foreign exchange management, to micro-aspects, such as the definition of portfolio bench- marks and the evaluation of investment managers. Furthermore, constraints arising from legal, human resources, asset markets, institutional and other aspects affect the actual achievability and implementation of reserves management objectives. While the macro-economic aspects S. Claessens Professor of International Finance Policy, Department of Economics and Econometrics, The University of Amsterdam; Senior Advisor, Financial Sector Vice-Presidency World Bank, and Centre for Economic Policy Research Fellow e-mail: stijn.claessens@uva.nl or sclaessens@worldbank.org J. Kreuser () Executive Director, The RisKontrol Group GmbH, Kramgasse 76, 3011 Bern, Switzerland e-mail: kreuser@riskontroller.com Springer