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Efficient estimation of extreme value-at-risks for standalone structural exchange rate risk

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  • He, Zhongfang

Abstract

The standalone structural exchange rate risk depends on the product of the future foreign currency earning and the change in the exchange rate. Its Value-at-Risk (VaR) implying an extremely high survival probability, usually exceeding 99.9%, is used in practice to determine its economic capital. This paper proposes a new conditional method to calculate such extreme VaRs that is shown to be more efficient than the conventional method of directly simulating from the joint distribution of the future foreign currency earning and the change in the exchange rate. The intuition of the proposed method is that, conditional on either the future foreign currency earning or the change in the exchange rate, the distribution of the structural exchange rate risk is usually analytically tractable. The proposed method can be implemented by solving a nonlinear equation via a simple one-dimensional numerical integration and is generally applicable under the distributional assumptions commonly employed in practice.

Suggested Citation

  • He, Zhongfang, 2014. "Efficient estimation of extreme value-at-risks for standalone structural exchange rate risk," MPRA Paper 57800, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:57800
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    References listed on IDEAS

    as
    1. Michael G. Papaioannou, 2006. "Exchange Rate Risk Measurement and Management: Issues and Approaches for Firms," South-Eastern Europe Journal of Economics, Association of Economic Universities of South and Eastern Europe and the Black Sea Region, vol. 4(2), pages 129-146.
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    More about this item

    Keywords

    value-at-risk; structural exchange rate risk; extreme value;
    All these keywords.

    JEL classification:

    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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