Impact of Foreign Exchange Risk on International Portfolios

The purpose of this article is to illustrate the impact of foreign exchange risk on international investments such as well diversified portfolios of assets. The centre part of this study is the Value at Risk (VaR) model, computed with the variance-covariance approach and assuming non-normality of returns and conditional volatility. The analysis is made on relative VaR (RVaR), the most important type of VaR, with a time horizon of 1 week and a 95% confidencelevel. The results indicate that currency movements have a major impact of on international portfolios, a finding that is supported by the unpredictable nature of FX rates and their nonexistent correlation with foreign equity returns. Also, establishing a general rule regarding currency risk will be of great use when dealing with hedge instruments.