Forecasting Nigeria Foreign Exchange Risk with Extreme Value Theory

Abstract

Foreign exchange forecasting is important in all forms of foreign investments and transactions, the skills which compliments the field of finance and related disciplines. This paper uses extreme value theory to estimate the Value-at-Risk (VaR) and Expected Shortfall (ES), by fitting negative log returns of Nigeria Naira (NGN) against nine other regional and world currencies into the Generalized Pareto Model. In this paper VaR is being used to determine daily foreign exchange risk on investments and the ES is used to determine the average risk over a period of time. Excess distribution and the tail of the underlying distribution were obtained over a required threshold. Empirical analysis shows that parameter estimate of the underlying distribution can be used to describe the performance of the VaR and ES. The findings contributes to the knowledge on foreign exchange forecasting and helps investors and policy makers in Nigeria to measure daily and possible risk over a period of time on certain investments.

Keywords: Extreme Value Theory, Value-at-Risk, Expected Shortfall, Foreign exchange rate, Nigeria Naira, GPD model