The Applied Study Of VaR To The Foreign Exchange Risk Management Of Commercial Banks In China

With the acceleration of globe economic integration, the tempo of international trade and international capital flow is suddenly advanced at a high rate, which makes the activities of commercial banks more and more internationally. Therefore, the current state of the development of such international activities has now become an important factor that affects the profitability of commercial banks. As processing those activities, commercial banks come to make great deal of profit as well as to face tremendous risk. Fairly all the activities are based on foreign currency which could bring commercial banks the specific risk on foreign currency as it fluctuates. As a result, the risk of foreign currency is now the most uncontrollable and kernel risk for commercial banks which plays an more and more important role on deciding the profitability of commercial banks.In addition, the interdependency between international capital flow and international trade are weakened gradually, and plenty of investment funds and institution investors show to be more frequently active around the international capital market. Both of the above have lead to the fluctuation of foreign currency and the augment of foreign currency risk for commercial banks. The Risk management of Foreign currency has long settled outside of China. However, because of the fixed exchange rate policy that we have practiced for such a long time, of the unconsciousness of such risk in Chinese administrator, we have been left behind in the risk management field. Fortunately, from 21st July 2005 on, we implementation a flexible exchange rate policy, which advanced the development of Chinese foreign currency market. Besides, administrative bureau practices a series of policies to thrive the foreign exchange market. The mechanism reform of RMB exchange rate and the relative policies have put some brand-new challenges through for the operation mechanism of Chinese commercial banks and their risk management with no doubt. This thesis discusses the application of VaR to the Foreign Exchange Risk Management of commercial banks in China. It divides into four chapters to carry on the analysis and the elaboration, the primary coverage is as follows:In the first chapter, we elaborate the management of foreign exchange risk and the usage of VaR. The foreign exchange risk means the lost that the commercial banks will sustain for the fluctuation of foreign exchange, and the probability that they can not obtain the profits as foreseen. Many banks already have the successful experience of taking advantage of VaR.In the second chapter, we introduce and analyse the system of VaR model. The caculating of VaR includes Variance-Covariance Method,Historical Simulation Approach and Monte Carlo Approach. The most popular method is the Variance-Covariance Method, though in fact we will utilize all of them. But we should notice that each method has its own advantages and disadvantages.Chapter three illustrates the application thought of VaR in details in the foreign exchange risk management of domestic commercial banks. We should build a basic environment of VaR application in two aspects. One is to improve the organization structure of foreign exchange risk management; the other is to enhance basic data gathering and information system construction. Besides, we should draw up the targets and policies in foreign exchange risk management. After those two take shape into written forms, what's more important is how to put it into practice. We need to lay emphasis on a tangible guarantee system: Risk Adjusted Performance Measurement. Finally, based on VaR we should recombination foreign exchange risk management procedure. One way is to compose risk measurement system centered on VaR. Another is to enrich risk control methods.In the fourth chapter we make empirical analysis of the application of VaR model in domestic commercial banks. We choose four most important currencies (Hong Kong Dollar, Dollar, Euro and Japanese) and view those four foreign currencies'exposures as a investment combination. Then we use both Variance-Covariance Method and Historical Simulation Approach respectively in the empirical analysis. The testing results turns out that both of those methods are acceptable. The times of computed VaR exceeding real loss and benefit is less in Historical Simulation Approach, which demonstrates that the VaR models are suitable and valid to some extend in the application of foreign exchange risk management of domestic commercial banks. Considering the real return ratio has shrill and thick tail phenomenon in Variance-Covariance Method, Historical Simulation Approach is more suitable in the research when historical data are sufficient.Generally, this dissertation mainly adopts quantitative analysis method and exercises some empirical studies to interpret the effects of VaR models'application in determining and measuring foreign exchange risk. Moreover, standard analysis and qualitative analysis are also been used to expound the logic thoughts of the whole article.The main contributions of this thesis are: With reference to the VaR model, the research that it had been applied to the risk management for the Chinese commercial banks has begun already, and mainly focused on the positive analysis about the security market; on the contrary, it is hardly used for the analysis of the Foreign Exchange Risk since the mechanism reform of our exchange rate. This thesis will do this assignment so as to extend the usage of the VaR model in China. Referring to the former research results, and applying the Variance-Covariance Method and Historical Simulation Approach of VaR to the calculation of Foreign Exchange Risk for Chinese commercial banks with general principles, this thesis tries to estimate the most potential lost under certain confidence level and duration for Chinese commercial banks. By comparing the calculating process, difference and results of both methods, and by the backtesting of such methods which could testify the validity of VaR model, this thesis gives some advice for domestic commercial banks on how to choose the proper calculation method of VaR model.