In search of robust methods for multi-currency portfolio construction by value at risk

Abstract

The main purpose of this paper is to select the most appropriate technique predicting precisely the exchange rate risk from three main approaches, namely, the Historical Simulation approach, the Variance–Covariance approach and the Monte Carlo Simulation approach. Our main finding shows that the historical simulation approach with exponentially weighted moving average, which exhibits the lowest out-of-sample loss, is the most appropriate method for value at risk estimation with regard to a multi-currency portfolio construction in the Taiwan foreign exchange market. Moreover, results in backtesting lend support to the accuracy of our proposed strategies at the 99% confidence level.