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The Applied Study of VaR to the Foreign Exchange Risk Management of Commercial Banks in China

Author: PiDaXi
Tutor: ZhangHeJin
School: Southwestern University of Finance and Economics
Course: Finance
Keywords: VaR Exchange rate risk Variance - covariance method Historical simulation method Monte Carlo Simulation
CLC: F832.2
Type: Master's thesis
Year: 2008
Downloads: 931
Quote: 4
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Abstract

With the accelerated process of global economic integration, international trade and international capital flows have experienced phenomenal growth, which makes the business of commercial banks gradually, international, international business development conditions have an impact on commercial bank profitability is an important factor . Commercial banks engaged in international business can obtain huge profits, but at the same time, also faces enormous risks. Since almost all international operations are conducted in foreign currencies as the carrier, once the exchange rate fluctuations, commercial banks will be exposed to exchange rate risk. Therefore, the exchange rate risk has become the most important international business banking, and the most difficult to control risk, the effect of its banking operations produced an increasingly important influence. In addition, international capital flows and international trade in the correlation between the gradual weakening, a large number of investment funds and institutional investors frequently active in the international market, these factors have led to the increased exchange rate volatility, commercial banks are facing Exchange rate risk also increased. Commercial banks in the foreign exchange rate risk management had already begun, and mature. While China is essentially due to the long fixed exchange rate regime, the foreign exchange market is relatively undeveloped, plus the bank's management on the lack of knowledge of the foreign exchange market volatility, making the current exchange rate of commercial banks risk management is relatively backward. However, from July 21, 2005, China began to implement a market-based, with reference to a basket of currencies, a managed floating exchange rate system. Moreover, in order to promote China's interbank foreign exchange market, regulators have issued a series of development and foreign exchange market related measures, including expanding the scope of the main foreign exchange spot market, the introduction of OTC transactions and market-maker system, expanding forward foreign exchange range, allowing the foreign exchange swaps and so on. The reform of RMB exchange rate mechanism and the related measures introduced undoubtedly China's commercial banks operating mechanism and risk management has brought new challenges, the urgent need for new risk management instruments and tools. This paper discusses the VaR model in China's commercial banks exchange rate risk management application. Why use VaR manage exchange rate risk? VaR is it? How to use VaR? VaR really suitable for China's commercial banks exchange rate risk management do? Problems of this series, analysis and research is the purpose and significance of this writing This paper is divided into four chapters analyze and explain the main contents are as follows: Chapter 1 describes the commercial bank exchange rate risk management and the use of VaR approach. Exchange rate risk refers to the commercial banks have suffered losses due to exchange rate movements and the expected benefits are difficult to realize the possibility of divided into transaction risk, currency risk and economic risk. China in the July 21, 2005 were RMB exchange rate formation mechanism reform, and subsequently unveiled a series of reform measures, which undoubtedly Exchange Rate Risk Management of Commercial Banks had brought opportunities and challenges, indicating China's commercial banks exchange Risk management has an important significance. Currently, the exchange rate risk measurement methods, including the mainstream method of currency exposure, VaR method, sensitivity analysis and scenario analysis. VaR method has many advantages, so it is in the world's commercial banks risk management applications are quite common, while China's commercial banks to exchange rate risk measurement basically stays in the use of foreign exchange risk exposure than a single ancient tools, and foreign compared to similar banks there is a big gap, VaR simply do not get a real promotion and use. Citibank and Japan's Mizuho Group, for example, they use methods to manage the exchange rate risk VaR is very successful, we can learn from their advanced experience, it is worth learning and use of China's commercial banks. Chapter 2 VaR model system for the analysis and presentation. Definition of VaR, there are two important parameters - holding period and confidence level, their choices for the VaR calculation results have a significant impact. The financial institutions on the length of the holding period is generally chosen in the financial market liquidity conditions and the actual sample size tradeoff between the two, while the selection is based on the confidence level VaR using different purposes. VaR is calculated including the variance - covariance method (parameter method), historical simulation and Monte Carlo simulation are three ways in which the variance - covariance method (parameter method) is the most common method of calculating VaR. Each calculation method has both advantages and limitations of the three methods in foreign commercial banks have a certain application. For free distribution option and close to normal probability density function of the variance - covariance method may be the best choice, the fastest, the measurement is relatively accurate. However, due to the presence of a normal distribution and linearity assumption portfolio for commercial bank portfolios with option positions not applicable, then only use historical simulation and Monte Carlo simulation. The former does not require any assumptions, easy to implement, but difficult to interpret. The latter does not require a linear portfolio, but the computing and data needs bigger than the other two methods, the model is also a corresponding increase in risk. Of course, because each calculation method has its limitations, we need to VaR backtesting model, this paper describes the application and is relatively easy to implement widespread failure rate test method, interval prediction method and Basel rules. At the same time, we should clearly recognize the limitations of VaR method itself, in the application process needs to be complemented by stress testing, scenario analysis. Chapter 3 detailed description of the VaR in China's commercial banks exchange rate risk management in the application of ideas. We should build applications based VaR environment, on the one hand to improve the exchange rate risk (market risk) management organizational structure, responsibilities to build a clear, distinct levels, information exchange and reporting lines clear organizational structure, on the other hand to strengthen the basis for data collection and information system, if there is no advanced risk management information system, it can not develop internal risk measurement models, thereby affecting the overall level of market risk management. We should also develop the exchange rate risk management objectives and policies. Imperative, commercial banks should be in itself an objective understanding of the degree of market risk, based on the combination of the overall business development strategy, develop their own risk management objectives, and in accordance with \the entire banking institutions, formal written market risk management policies. When a commercial bank on exchange rate risk management objectives and policies form a written document, the more important is its implementation, we want to emphasize here, it is a tangible assurance mechanisms: risk-adjusted performance evaluation (RAPM ). In addition, we should be based on the exchange rate risk management VaR restructuring process, on the one hand in order to build the core of the risk measure VaR methodology, in accordance with the exchange rate risk management front, middle and back distinguish different levels of risk measurement methods, on the other To enrich risk control measures, the bank must be integrated into the exchange rate risk faced by the nature of risk factors such as the willingness and ability to select appropriate risk control measures. Chapter 4 VaR method in commercial bank exchange rate risk management application made empirical analysis. Given the annual report of China's commercial banks foreign exchange composition, we selected four major currencies (dollar, U.S. dollar, euro and yen), these four foreign exchange open positions can be seen as an investment portfolio. In order to facilitate the calculation and comparison of the four foreign exchange open positions are 10 billion yuan, and the sample interval position does not change. At this point, we have chosen a holding period of one day, a confidence level of 95%. The paper selected variance - covariance method (parameter method), historical simulation VaR model for China's commercial banks exchange rate risk management application made empirical analysis, we selected four foreign exchange 2005.7.22-2006.7.21 year reference exchange rate as a sample, number of samples n = 246; test samples are selected 2006.7.21-2007.6.7 four kinds of foreign exchange reference rates, the number of samples is m = 205. For comparison the variance - covariance method (parameter method), historical simulation method, the paper only July 21, 2006 the VaR calculation, for example, the results of both methods are close. Finally, the two methods were calculated VaR backtesting. Backtesting results show that the statistical variance - covariance method and historical simulation method is acceptable, historical simulation VaR calculated for fewer than the actual loss proved VaR method in the exchange rate risk management in commercial banks have some applicability and effectiveness. Taking into account the variance - covariance method exists under the effective yield fat tail phenomenon in the case of sufficient historical data, historical simulation method using a portfolio of commercial banks has more applicability. Overall, this paper, using quantitative analysis methods, the application of empirical analysis shows typical VaR calculation methods in the determination and the role of the exchange rate risk measurement and adaptability. And supplemented by normative analysis and qualitative analysis to elaborate exchange VaR in Risk Management of Commercial Banks in the application of ideas in order to provide a reference point for the bank manager. The main contribution of this paper is to: VaR model for risk management in China's commercial banks Studies on the application has started very early, and were mainly concentrated in the empirical analysis of the stock market, but the exchange rate risk for the study is relatively small, and the use of exchange rates Since the reform of the formation mechanism of foreign exchange rate data for commercial banks to exchange rate risk is almost no empirical research. This study is the difference with previous studies using the exchange rate formation mechanism reform of foreign exchange rates since the data rates of commercial banks risk empirical research aimed at expanding VaR method of empirical research in the field of Chinese and scope of reference to historical findings the VaR variance - covariance method and historical simulation method in the case of general application applied to Chinese domestic commercial banks to exchange rate risk is measured using two methods to predict commercial bank at a certain level of confidence and holding may occur during Maximum potential losses. Measured by two methods and measurement results of the analysis process, comparing the two methods differ, and through the two methods backtesting tests verify the validity of the model for the domestic commercial banks with their own reality select the appropriate measurement method provides VaR reference.

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