Exchange rate risk measurement and management : issues and approaches for public debt managers.
Authors
Michael Papaioannou
Abstract
This paper presents conventional and alternative exchange-rate risk measures
for government bonds, and outlines liability management operations for dealing
with currency exposure. These risk measures and liability management operations
are analyzed from the perspective of a sovereign debt manager. In particular,
we examine the VaR statistic as a prominent measure of exchange rate risk
exposure, along with an integrated VaR approach for the simultaneous estimation
of a bonded portfolio’s interest rate and exchange rate risk; the expected
shortfall measure of exchange rate risk; and the spectral risk measure. The liability
management operations outlined are debt buybacks, debt swaps and currency
derivatives. These operations are extensively used by public debt managers
of both developed and emerging market countries to mitigate or eliminate
exchange rate risk of public debt portfolios and to reduce external debt servicing
costs. Also, the Cost at Risk is introduced as an approach to assess debt strategies,
and best practices in managing the exchange rate risk exposure of public debt are
provided. Further, experiences of external public debt management from selected
south-east European countries are offered to illustrate the application of sovereign
liability management operations in this region.