Modeling jumps in returns of financial assets as M4 processes: Measured exchange rate exposure of Asian equity portfolio

Abstract

Previous work on the exposure of equity markets to exchange rate risk, surprisingly, found stock returns were not significantly affected by exchange rate fluctuations. In this paper, we examine the relation between China, Japan and USA MSCI (Morgan & Stanley Capital International) daily equity index returns and SAFE (State Administration of Foreign Exchange) exchange rate returns of Chinese RMB and Japanese Yen in US dollar. We find a significant relation between Asian foreign equity stock returns and Chinese RMB and Japanese Yen exchange rate returns. This article incorporates foreign exchange values as partial determinants of Asian foreign equity market returns and suggests that currency risk is of hedging concern to investors with implications for portfolio management. We implement our result in portfolio’s CaR determination under VaR constraints.

Keywords

Exchange rate exposure / extreme value theory / M4 process

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