Volume 23, Number 3 (February 2021)
Warrington College of Business, University of Florida
This issue of The Journal of Risk contains papers that illustrate the application of mathematical optimization to currency carry trades under liquidity constraints and assess the impact of trade war on cryptocurrencies. Systemic risk ampliﬁcation and the relevance of the Fundamental Review of the Trading Book (FRTB) to base currency reporting are also addressed.
In our ﬁrst paper, “Optimal foreign exchange hedge tenor with liquidity risk”, Rongju Zhang, Mark Aarons and Gregoire Loeper propose a model to help determine the best tenor mix of foreign exchange forwards in order to optimize currency carry beneﬁts while accounting for cashﬂow risk whenever these contracts mature. Under the assumption of mean-reversion of spot exchange rates, the authors show that the optimal tenor mix is very sensitive to the target cashﬂow at risk and the spot volatility.
In “Optimization of systemic risk: reallocation of assets based on bank networks”, the issue’s second paper, Hu Wang and Shou wei Li build a contagion model that combines two channels–solvency via interbank exposures and ﬁre sales via overlapping portfolios – in such a way that balance sheets are optimized to reduce systemic risk. The authors ﬁnd that decreasing interbank assets and increasing common asset holdings can reduce systemic risk, and that a high Herﬁndhal–Hirschman Index plays a critical role in risk ampliﬁcation.
“A review of the foreign exchange base currency approach under the standardized approach of the Fundamental Review of the Trading Book and issues related to the pegged reporting currency”, the third paper in this issue, sees Ted Yu demonstrating the invariance of the foreign exchange delta risk charge of any reporting currency under a standardized FRTB approach. The author contrasts this with the variance resulting from using triangular relations between currency pairs.
In our fourth and ﬁnal paper, “Forecasting Bitcoin returns: is there a role for the US–China trade war?”, Vasilios Plakandaras, Elie Bouri and Rangan Gupta conduct an empirical study that shows Bitcoin returns to be insulated from trade frictions. Theauthors’resultsarebasedontheout-of-sampleperformanceofpredictedBitcoin returns through a variety of models, including ordinary least squares, support vector regression and the least absolute shrinkage and selection operator (LASSO).
Papers in this issue
Optimization of systemic risk: reallocation of assets based on bank networks
In this paper, the authors investigate the optimization of systemic risk based on DebtRank by considering two contagion channels: interbank lending and common asset holdings.
Forecasting Bitcoin returns: is there a role for the US–China trade war?
In this paper, the authors extend the related literature by examining whether the information on the US–China trade war can be used to forecast the future path of Bitcoin returns, controlling for various explanatory variables.
A review of the foreign exchange base currency approach under the standardized approach of the Fundamental Review of the Trading Book and issues related to the pegged reporting currency
When we adopt the parameters in the BCBS standards to calculate the delta risk charge, anomalies in the risk charges for the same risk exposure are found under different approaches and under different reporting currencies. The anomalies increase when the…
Optimal foreign exchange hedge tenor with liquidity risk
The authors develop an optimal currency hedging strategy that allows fund managers who own foreign assets to choose the hedge tenors that will maximize their foreign exchange carry returns within a liquidity risk constraint.