Modelling Foreign Exchange Risk in a Managed Float Regime: Evidence from Pakistan

Abstract

We study the implications of the exchange rate regimes (managed vs. floating) for implementing risk assessment models using Pakistan data; the country seems to manage its currency mainly against the US dollar, but to a lesser extent against other hard currencies. We test five variations of the Value-at-Risk (VaR) model, including models based on the Extreme Value Theory (EVT). Our results indicate that these models do not perform as well for the currency pairs with the managed float (USD/PKR and JPY/PKR). It implies that the managed float regime imposes additional risk and cost on economic agents. The findings of this paper provide additional support for following a free float policy, and underscore the importance of the role the exchange rate regime plays in facilitating management of risk by economic agents. Keywords: Value at Risk, Risk Management, Managed Float, Extreme Value Theory