Abstract: The paper incorporates buffer stock model with habit formation and builds a dynamic model which contains both international payment volatility and habit formation factors. Empirical studies using survey data of china’s foreign reserve from 1996 to 2009 show that: (1) a county’s foreign reserve is a function of international payment’s uncertainty and opportunity cost, whereas there exits a long term equilibrium among the three factors mentioned above, that is to say BS foreign reserve prediction model holds good for China. (2) the bigger the parameter of habit formation becomes, the more reserve will accumulate and the less impact international payment volatility will have on reserve. (3) It is because habit formation is taken into account that the estimated elasticity of reserve holdings with respect to international payment volatility and opportunity cost becomes extremely close to the predictions of the theoretical model.

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