During the past few decades, economic policy makers observed an enormous increment in central bank‟s holding of international reserves. The main reasons behind reserves accumulation includes precautionary motive, achieving confidence and to improve credit ratings. High reserves accumulation will largely reduce country‟s ability to address their basic issues i.e. health, education and outstanding economic problems. Th study examines optimal level of international reserves for Pakistan over the period 1982-2017 by including sovereign risk associated with default on external debt. For this purpose, we used annual data and adopt reserve optimizing model which require minimization of central bank‟s total cost of holding reserves. The cost function includes cost of positive reserves, cost of reserve depletion and their associated probabilities. For estimating cost of reserve depletion, the study utilized H-P filter method and imposed range of annual output loss associated with global economic crisis as cost of reserve depletion for the entire period. In order to compute absolute and marginal probabilities, the risk premium equation has been carried out. Through estimating risk premium equation, it is observed that two independent variable that is shortterm external debt to reserves and volatility of foreign portfolio investment is significant at 5% level .The approach estimation suggests that simulated optimum reserves remains greater as that of actual reserves till 2004-05 and then in subsequent periods, actual reserves are much higher than optimum reserves. The monetary authority should maintain optimal level of reserves so that the cost of holding reserves should not exceed its benefits. Therefore, appropriate steps should be taken by SBP in order to restructure management policies regarding reserves to enhance its performance. Supervisor:- Dr. Ahsan ul Haq Satti