Foreign exchange reserves are important assets of a country because they are significantly affected by exchange rate policy, monetary policy, regulations, external instability and the impact of the crisis that may come from the environment. Without the adequate reserves the Government may be forced to change the trade and exchange rate policies, which may not be in the long run interest of the country. Accumulation of foreign reserves involve two types of costs, the opportunity cost and the adjustment cost and we cannot say holding maximum level of reserves is beneficial for the economy. When accumulation of reserves exceeds the optimal level, it shows the inefficient allocation of resources. The objective of the study is to check the optimal level of foreign exchange reserves holdings using quarterly data from 2000 to 2015 of Pakistan. The study shows that except few quarters Pakistan’s actual level of foreign reserves holding is higher than the optimal level. The results of Buffer stock model used in our study, does not indicate the optimal behaviour of foreign reserves holding. Implications that flow from these results are that State bank of Pakistan must be active in the management of reserves accumulation because we bear the cost of reserves holding by sacrificing the country’s investment. The study suggests that a proper macroeconomic policy and not just the exchange rate and trade policy are required for the optimal levels of foreign exchange reserves. Supervisor:- Dr. Attiya Yasmin Javid