the currency risk. the assumption of the diversification is that the covariation between individual assets ’ price movements is not always perfectly positive. this means that a portfolio ’ s total movement, that is, volatility, will be less. in connection with large movements in the foreign exchange market, an overly narrow currency composition might lead to large declines in value, which could in turn lead to a heavy fall in capital. given this, we quite simply try to achieve a currency allocation that will minimise the currency risk measured in swedish kronor, given the currencies we can hold and given our intervention need. our choice is based on a quantitative analysis using fundamental and standard portfolio theory 8. our analysis does not take into account the expected earnings in currency, but merely the currencies ’ estimated volatility and mutual correlations. the result of our analysis is illustrated in the following diagram ( see figure 2 ). this and other questions regarding the riksbank ’ s need to have its own capital are discussed in ernhagen, vesterlund & viotti ( 2002 ). for a more detailed discussion of the riksbank ’ s intervention policy, see heikensten & borg ( 2002 ). this refers to what is known as the mean - variance analysis that was originally produced by harry m. markowitz in the 1950s. because of the sensitivity of this model, the analysis is supplemented by value - at - risk calculations, risk contribution analyses and stress tests. value - at - risk is an estimate of potential loss risk and is defined as the largest expected decline in value of an asset, or an asset portfolio, with a specific probability and over a specific period of time. as you can see, our largest holding is in euro. this is not surprising, as the relationship between the euro and the krona has remained relatively stable. historically, the currency risk attributable to our euro holding has thus been less than that attributable to other currencies in the reserve. the dollar, on the other hand, has been one of the highest risk currencies. the fact that we nevertheless have a relatively large dollar exposure is due to its importance as intervention currency. it is reasonable to wonder why we do not choose to convert some of the currency assets into swedish assets as long as we have a floating exchange rate regime. in this way the currency risk on these assets would disappear completely. in practice, however, this is not so

##bank ’ s various tasks that is the most important explanatory factor behind the focus of our asset management. it is only when we have reasonably ensured that we can carry out these tasks that we take financial risks in order to generate earnings. in the following i shall describe in more detail how this balance is attained. in practice it is a question of the riksbank ’ s exposure to three different types of risk ; currency risk, interest rate risk and credit risk. currency risk currency risk is by far the largest risk in our balance sheet. it arises when the krona appreciates or depreciates in relation to the currencies in the foreign exchange reserve. this means that the riksbank ’ s profit and loss account and balance sheet are valued in kronor. an appreciation of the krona reduces the value of our foreign exchange reserve and a depreciation increases it. when the krona appreciates it is thus a negative event to the extent that it leads to exchange losses that are booked in the riksbank ’ s balance sheet. if these losses are too large, there is a risk that they must be covered by the capital the riksbank has allocated for use in potential financial crises and to cover the bank ’ s day - to - day operations. there is therefore reason to limit the impact of a krona appreciation on the riksbank ’ s results. however, the possibility to do so is limited by the fact that we must have currency assets in order to intervene in the foreign exchange market. the need for intervention capacity in the form of foreign assets is determined by the prevailing exchange rate regime. under a fixed exchange rate regime the central bank may need to intervene relatively often, which means that the need for intervention assets is considerable. this need is usually much lower with a floating exchange rate regime 7. however, according to law, the riksbank must be able to implement the exchange rate regime that the government has stipulated for the krona, regardless of whether this is fixed or floating. this means that the currency holding is ultimately determined by the needs of a fixed exchange rate regime. at present, however, we have a floating exchange rate regime, which gives us scope to limit the currency risk. we do this by ensuring that our holdings of the important intervention currencies, i. e. euro and us dollar, are no larger than can be justified for reasons of intervention or diversification. diversification is the possibility we have to reduce