Exchange Rate Risk and International Equity Portfolio Diversification: A South African Investor’s Perspective

This paper examines the impact of foreign exchange rate risk on the expected return of a South African investor’s portfolio. A GJR-GARCH based Value at Risk (VaR) model was used to compute the upside and downside risk measures. Data sample of ten emerging stock markets were utilized: from 1 January 2000 to 6 March 2019. The tails of negative and positive asset returns were modelled with the help of the generalized Pareto distribution (GPD) method in order to separate left tail risk from right tail risk. Our findings reveal that international diversification substantially enhances the South African investor’s portfolio return, with a noticeable yield increase in China, Brazil, Argentina, Mexico, and Russia. Furthermore, the Singaporean dollar and Chinese Yuan are found to have a negative impact on the portfolio return, while the rest of the currencies have a positive impact on the portfolio return. Also, we found that exchange rate risk is underestimated when using the variance-covariance method as it fails to capture the swing movement of currency in the minimum- value at risk optimization