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

Farhan Akbar () and Thierry Chauveau
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Farhan Akbar: PhD candidate MSE Paris 1 University (Pantheon Sorbonne) France

No 30, SBP Working Paper Series from State Bank of Pakistan, Research Department

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

Keywords: Value-at-Risk; public debt management; exchange rate risk (search for similar items in EconPapers)
JEL-codes: G18 H63 (search for similar items in EconPapers)
Date: 2009-06
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