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Extreme Moves in Foreign Exchange Rates and Risk Limit Setting

Author

Listed:
  • Michel Dacorogna

    (Converium)

  • Peter Blum

    (Converium)

Abstract

Foreign exchange rates can be subject to considerable daily fluctuations (up to 5 percent within one day). This can, in certain cases, cause serious losses on open overnight positions. Given a maximum tolerable loss for a company, limits have to be set on open overnight positions in foreign currencies. Usually, these limits are determined by using a normal ("Gaussian") model for the daily fluctuations. In our study we illustrate how this common model sometimes quite strongly underestimates the actual extreme risks and, based on methods from the Extreme Value Theory (EVT), we propose and justify a more accurate model.

Suggested Citation

  • Michel Dacorogna & Peter Blum, 2003. "Extreme Moves in Foreign Exchange Rates and Risk Limit Setting," Risk and Insurance 0306004, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpri:0306004
    Note: Type of Document - Acrobat PDF; prepared on IBM PC; to print on HP A4; pages: 12 ; figures: included
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    File URL: https://econwpa.ub.uni-muenchen.de/econ-wp/ri/papers/0306/0306004.pdf
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    References listed on IDEAS

    as
    1. Olivier V. Pictet & Michel M. Dacorogna & Ulrich A. Muller, 1996. "Hill, Bootstrap and Jackknife Estimators for Heavy Tails," Working Papers 1996-12-10, Olsen and Associates.
    2. Longin, Francois M, 1996. "The Asymptotic Distribution of Extreme Stock Market Returns," The Journal of Business, University of Chicago Press, vol. 69(3), pages 383-408, July.
    3. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    4. Gençay, Ramazan & Dacorogna, Michel & Muller, Ulrich A. & Pictet, Olivier & Olsen, Richard, 2001. "An Introduction to High-Frequency Finance," Elsevier Monographs, Elsevier, edition 1, number 9780122796715.
    Full references (including those not matched with items on IDEAS)

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    Cited by:

    1. Ana-Maria Gavril, 2009. "Exchange Rate Risk: Heads or Tails," Advances in Economic and Financial Research - DOFIN Working Paper Series 35, Bucharest University of Economics, Center for Advanced Research in Finance and Banking - CARFIB.

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    More about this item

    Keywords

    extreme value theory; risk management; foreign exchange; time series analysis;
    All these keywords.

    JEL classification:

    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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