Trading Turkey's External and Internal Risks: A Value at Risk Analysis

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In earlier work we showed we could not reject the hypothesis that returns to investments in Turkey's stock market were positive functions of risk generated by the World outside Turkey and by risks unique to Turkey. We found statistical evidence of Turkey's internal risks producing substantial returns and changes in returns over time. This article carries the analysis further by bringing our earlier results into a more concrete environment, asking whether these risks can be profitably managed as a practical matter. In particular we consider results of two strategies in trading cross-market portfolios. We examine a long position in the ISE Dollar Return Index, offset by a short position in the S&P 500 Composite Total Returns Index. In this analysis we verify profitability directly by computing actual profit produced by an implementable trading strategy. We identify our two portfolio management strategies using Value-at-Risk-inspired measures of risk and return. We also examine the importance of secondary issues in portfolio management, such as identification of buy and sell signals and selection of a trading position. We examine two issues determining the performance of a trading position in this cross-market portfolio. First, are there predictable and substantial periods of time when it is good to be long Turkey and short the Rest of the World and the reverse? Second, how important is it to monitor the time path of the risks unique to Turkey's Financial Markets in comparing returns in Turkish and World Markets? Our answers are first, Yes and second, Very.