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Extreme Moves in Foreign Exchange Rates and Risk Limit Setting

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Author Info

  • 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.

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File URL: http://128.118.178.162/eps/ri/papers/0306/0306004.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Risk and Insurance with number 0306004.

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Length: 12 pages
Date of creation: 19 Jun 2003
Date of revision:
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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Web page: http://128.118.178.162

Related research

Keywords: extreme value theory; risk management; foreign exchange; time series analysis;

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References

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  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. Koedijk, C.G. & Schafgans, M.M.A. & Vries, C.G. de, 1990. "The tail index of exchange rate returns," Open Access publications from Tilburg University urn:nbn:nl:ui:12-3108722, Tilburg University.
  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 637-54, May-June.
  4. 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.
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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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