Interest Rate Arbitrage in Currency Baskets: Forecasting Weights and Measuring Risk

By Peter F. Christoffersen, Lorenzo Giorgianni

January 1, 1999

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Peter F. Christoffersen, and Lorenzo Giorgianni. Interest Rate Arbitrage in Currency Baskets: Forecasting Weights and Measuring Risk, (USA: International Monetary Fund, 1999) accessed December 22, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

When constructing hedged interest rate arbitrage portfolios for basket currencies, two issues arise: first, how are the unknown future basket weights optimally forecasted from past exchange rate data? And, second, how is risk—in terms of the conditional variance of expected profits from the interest rate arbitrage portfolio—appropriately measured when the basket weights are time-varying? Answers to these questions are provided within a time-varying parameter modeling framework estimated through the Kalman filter. An empirical application is devoted to the experience of the Thai baht currency basket (January 1992–February 1997).

Subject: Banking, Conventional peg, Currencies, Exchange rates, Expenditure, Financial regulation and supervision, Foreign exchange, Hedging, Money, Public expenditure review

Keywords: Basket weight, Cointegrating regression, Cointegration, Conventional peg, Cross-currency risk, Currencies, Dollar exchange rate, Dollar rate, Exchange rate, Exchange Rates, Hedging, Intervention rate, Public expenditure review, Risk-adjusted return, Standard deviation, Time-varying Parameters, U.S. dollar, WP

Publication Details

Pages:

30
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 1999/016
Stock No:

WPIEA0161999
ISBN:

9781451843385
ISSN:

1018-5941

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