Portfolio Performance of the SDR and Reserve Currencies: Tests Using the ArCH Methodology

February 1, 1993

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Tugrul Temel, and Michael G. Papaioannou Portfolio Performance of the SDR and Reserve Currencies: Tests Using the ArCH Methodology, (USA: International Monetary Fund, 1993) accessed November 8, 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

In managing their foreign exchange exposure, international investors, including central banks, often compare actual portfolios with hypothetical portfolios that have been calculated using certain assumptions regarding the statistical properties of interest rates and exchange rates. One of these assumptions is that the variability of returns on various currency assets is time invariant. This assumption is tested in this paper using autoregressive conditional heteroskedastic (ARCH) models. Using weekly aata for the period February 1982 to December 1991 for major reserve currencies, including the SDR, we find evidence that the variances of returns do vary over time (i.e., they do not exhibit stationarity) and that ARCH models that specify changing variances are superior to models that assume constant variance. By incorrectly assuming constant variability of returns, currency-asset allocations are not necessarily optimal and the measures of riskiness of a fixed-income portfolio may not be accurate. Furthermore, the error introduced by incorrectly assuming stationarity is smaller with the SDR than with any other national currency in the portfolio to be managed.

Subject: Commodities, Currencies, Exchange rates, Foreign exchange, Gold, Money, National accounts, Return on investment

Keywords: ARCH effect, ARCH model, ARCH process, ARCH specification, ARCH-family model, Currencies, Exchange rates, Global, Gold, Kurtosis statistic, Math, Return on investment, 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. 1993/010
Stock No:

WPIEA0101993
ISBN:

9781451842630
ISSN:

1018-5941

Notes

Also published in Staff Papers, Vol. 40, No. 3, September 1993.

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