Exchange rate risk in the Government Pension Fund Global

Abstract

The Government Pension Fund Global (the Fund) is an important instrument of national saving. In a national perspective, the Fund's role is to save from the cur- rent export surplus (oil and gas) to nance future purchases of goods and services produced abroad (imports). In this perspective, exchange rate risk relates to the di erence between the currency allocation in the Fund and the currency composi- tion of future imports. Exchange rate risk amounts to deviations from international purchasing power parity (PPP) in tradable goods. A literature review suggests that the evidence for PPP in the long run is considerably stronger today than commonly thought 10-15 years ago. Also, it seems justi ed to expect large deviations from PPP to be signi cantly more short-lived than previously thought. Given the Fund's long investment horizon and regular withdrawals through the scal policy guide- line, exchange rate risk seems small. This warrants a change in the geographical allocation of the Fund. Today, more than half of the Fund's capital is invested in Europe { a certain form of \home bias." There no longer appears to be a basis for such a strong concentration of the investments. In fact, an argument can be made to invest more in countries that are farther from home, e.g. in emerging markets.