Exchange Rate Risk Measurement and Management: Issues and Approaches for Public Debt Managers

This paper presents conventional and alternative exchange-rate risk measures for government bonds, and outlines liability management operations for dealing with currency exposure. These risk measures and liability management operations are analyzed from the perspective of a sovereign debt manager. In particular, we examine the VaR statistic as a prominent measure of exchange rate risk exposure, along with an integrated VaR approach for the simultaneous estimation of a bonded portfolio’s interest rate and exchange rate risk; the expected shortfall measure of exchange rate risk; and the spectral risk measure. The liability management operations outlined are debt buybacks, debt swaps and currency derivatives. These operations are extensively used by public debt managers of both developed and emerging market countries to mitigate or eliminate exchange rate risk of public debt portfolios and to reduce external debt servicing costs. Also, the cost at Risk is introduced as an approach to assess debt strategies, and best practices in managing the exchange rate risk exposure of public debt are provided. Further, experiences of external public debt management from selected south-east European countries are offered to illustrate the application of sovereign liability management operations in this region.