Exchange Rate Risk Measurement For Commercial Banks Under Event Risk

Since the Bretton Woods system collapsed in1970s, great changes havetaken place in the world economic and financial environment. How to guardagainst exchange rate risk of commercial banks has become the focus of thestudy. Especially in the recent ten years, continued global outbreak of thefinancial crisis, the credit crisis with the global economic integration arebecoming more and more serious bundling economies together. On July21st2005, China also began to implement the managed floating exchange ratesystem based on market supply and demand and the reference to a basket ofcurrencies. Then the Chinese foreign exchange policy was gradually liberalized,first from daily floating the upper limit of0.3%in2005to1%in2012.Additionally, there is a series of reform measures such as introducing thetransaction by inquiry, which causes our Chinese banks suffer increasingpotential risk of exchange rate fluctuations, especially the influence of event riskfluctuation. Therefore, under such circumstance, how the commercial banksguard against exchange rate risks has become a very important link in theprocess of business. Measurement is the basis of prevention. Effectively riskforecasting and statistic will be a key element for whether the bank will besuccess in the new century.However, most banks in China still use original foreign exchange exposuremethod to account foreign exchange risk. Although in recent years, many domestic scholars use VAR model to evaluate the risk, and even somecombination of the GARCH regression model to predict future data, but mostresearchers only consider the general risk measurement, and did not take intoaccount the event risk. Though a few articles cover the event risk effects,scholars usually use the pressure test to observe the event risk withoutestablishing related models, or using extreme value theory method to analysisthrough the fitting the tail. Although this model has a certain effect, but itignores the assumption that financial asset is time-varying and asset returns areindependent distribution. Hence, these two methods in the study of event risk isnot particularly desirable. In this paper, GARJI model which can better identifyrisk events is proposed.In this paper, the definition, classification of the exchange rate risk, and thereason and consequences of it is introduced in the first place, which is followedby some common foreign exchange rate risk analysis methods, including foreignexchange exposure management method and VAR analysis method as well assome of the current commonly used risk event analysis method. Then itproposed GARJI model which is suitable both in general and event risk, andapplied this model in2006to2012China’s exchange rate market in the threelargest foreign exchange market: RMB/USD, RMB/EURO, RMB/YEN, findthe abnormal fluctuations days, and put forward reasonable warning linestandard. After analysis and comparison, the conclusion of this paper is theparameters of the yen and euro fitting perfectly, catching up several fluctuationsover the years causing by the abnormal events, and they passed through the testof hypothesis. Because of the exchange rate of RMB to USD is controlled, andthe limited floating rate is too low, it cannot form a risk event for USD. Theresult of USD is not so well and could not pass the test of hypothesis, but it canstill distinguish between some abnormal fluctuations on the jump probability. Atthe end, this paper also puts forward some improvement suggestions andopinions of some foreign exchange management measures for domestic banks inorder to match the prediction model to achieve better control of the exchangerate risk..