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An Analysis of Exchange Rate Risk Exposure Related to Public Debt Portfolio of Pakistan: Beyond Delta-Normal VAR Approach

Author

Listed:
  • Farhan Akbar

    () (PhD candidate MSE Paris 1 University (Pantheon Sorbonne) France)

  • Thierry Chauveau

Abstract

The aim of this study is to assess and analyze exchange rate risk related to three currencies i.e. Euro, American Dollar and Japanese yen on Public Debt Portfolio of Pakistan (PDPP) through Value-at-risk (VAR) methodology from year 2001 to 2006. Annual returns series of exchange rates show better convergence to normal distribution than for the whole period from 2001-2006. Moreover VAR through Monte Carlo (MC) and Historical Simulation (HS) also produce results in line with Delta-Normal Method, convergence of VAR results is more evident in the case of Delta-Normal and MC, validating that the assumption of Normality is not unreasonable. VAR obtained through three methods exhibit considerable decline of maximum potential loss over the years, thus signs of improvements in managing exchange risk. Our study reveals that Pakistan’s Public debt policy management with respect to exchange rate exposure lacks hedging Strategy. This is evident from the fact that none of the currencies constituting PDPP has negative Beta or negative component VAR. Only Dollar has Beta less than unity for all the six years. Beta and Marginal VAR analysis reveal that individually Dollar is the least risky and Japanese yen as the most risky currency constituting PDPP. Throughout the period marginal VAR associated to Dollar never exceeds to those of Euro and Jyen. While Jyen has the highest Beta throughout the period and we obtain the same result through marginal VAR analysis too. Dollar, despite being individually least risky currency throughout the period is found to be contributing highest risk as component VAR in certain years that is mainly due to its positive Beta which declines considerably over the years and large weight structure in the PDPP. Lower component VAR of Dollar in certain years is mainly attributed to its exceptional decline in Beta values. Not only Beta and component VAR analysis reveal lack of hedging strategy but this is also confirmed by the Best Hedge analysis, where also all the results exhibit negative signs for all the years throughout the period, suggesting for lower exposure in all currencies including Dollar. Length: 51 pages

Suggested Citation

  • Farhan Akbar & Thierry Chauveau, 2009. "An Analysis of Exchange Rate Risk Exposure Related to Public Debt Portfolio of Pakistan: Beyond Delta-Normal VAR Approach," SBP Working Paper Series 30, State Bank of Pakistan, Research Department.
  • Handle: RePEc:sbp:wpaper:30
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    File URL: http://www.sbp.org.pk/repec/sbp/wpaper/wp30.pdf
    File Function: First version, 2009
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    References listed on IDEAS

    as
    1. David Jamieson Bolder, 2003. "A Stochastic Simulation Framework for the Government of Canada's Debt Strategy," Staff Working Papers 03-10, Bank of Canada.
    2. World Bank, 2007. "Managing Public Debt : From Diagnostics to Reform Implementation," World Bank Publications, The World Bank, number 6658.
    3. Nelson, Daniel B., 1992. "Filtering and forecasting with misspecified ARCH models I : Getting the right variance with the wrong model," Journal of Econometrics, Elsevier, vol. 52(1-2), pages 61-90.
    4. Diego Nocetti, 2006. "Central bank´s value at risk and financial crises: An application to the 2001 Argentine crisis," Journal of Applied Economics, Universidad del CEMA, vol. 9, pages 381-402, November.
    5. Faezeh Raei & Selim Cakir, 2007. "Sukuk vs. Eurobonds; Is There a Difference in Value-at-Risk?," IMF Working Papers 07/237, International Monetary Fund.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Value-at-Risk; public debt management; exchange rate risk;

    JEL classification:

    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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