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The dependence structure and portfolio risk of Malaysia's foreign exchange rates: the Bayesian GARCH–EVT–copula model

Xiu Wei Yeap (Economics Program, School of Social Sciences, Universiti Sains Malaysia, Gelugor, Malaysia)
Hooi Hooi Lean (Economics Program, School of Social Sciences, Universiti Sains Malaysia, Gelugor, Malaysia)
Marius Galabe Sampid (PhD Applied Mathematics, Risk Analyst at Deutsche Bank Berlin, Berlin, Germany)
Haslifah Mohamad Hasim (Mathematical Sciences, School of Mathematical and Computer Sciences, Heriot-Watt University, Edinburgh, UK)

International Journal of Emerging Markets

ISSN: 1746-8809

Article publication date: 2 October 2020

Issue publication date: 7 July 2021

Abstract

Purpose

This paper investigates the dependence structure and market risk of the currency exchange rate portfolio from the Malaysian ringgit perspective.

Design/methodology/approach

The marginal return of the five major exchange rates series, i.e. United States dollar (USD), Japanese yen (JPY), Singapore dollar (SGD), Thai baht (THB) and Chinese Yuan Renminbi (CNY) are modelled by the Bayesian generalized autoregressive conditional heteroskedasticity (GARCH) (1,1) model with Student's t innovations. In addition, five different copulas, such as Gumbel, Clayton, Frank, Gaussian and Student's t, are applied for modelling the joint distribution for examining the dependence structure of the five currencies. Moreover, the portfolio risk is measured by Value at Risk (VaR) that considers the extreme events through the extreme value theory (EVT).

Findings

The finding shows that Gumbel and Student's t are the best-fitted Archimedean and elliptical copulas, for the five currencies. The dependence structure is asymmetric and heavy tailed.

Research limitations/implications

The findings of this paper have important implications for diversification decision and hedging problems for investors who involving in foreign currencies. The authors found that the portfolio is diversified with the consideration of extreme events. Therefore, investors who are holding an individual currency with VaR higher than the portfolio may consider adding other currencies used in this paper for hedging.

Originality/value

This is the first paper estimating VaR of a currency exchange rate portfolio using a combination of Bayesian GARCH model, EVT and copula theory. Moreover, the VaR of the currency exchange rate portfolio can be used as a benchmark of the currency exchange market risk.

Keywords

Acknowledgements

Funding from the Bridging Grant No. 304/PSOSIAL/6316029 by Universiti Sains Malaysia is acknowledged.

Citation

Yeap, X.W., Lean, H.H., Sampid, M.G. and Mohamad Hasim, H. (2021), "The dependence structure and portfolio risk of Malaysia's foreign exchange rates: the Bayesian GARCH–EVT–copula model", International Journal of Emerging Markets, Vol. 16 No. 5, pp. 952-974. https://doi.org/10.1108/IJOEM-02-2020-0169

Publisher

:

Emerald Publishing Limited

Copyright © 2020, Emerald Publishing Limited