Exchange Rate Risks of International Portfolio Investments: Comparative Analysis of Ukrainian and Other Frontier Markets
Keywords:International portfolio investments, exchange rate risk, frontier markets, Ukraine, relative foreign exchange return differential, Sharpe ratio
The paper investigates the role of the exchange rate risk of investing in Ukrainian and other frontier equity markets during the period between 2006 and 2016. It argues that among frontier markets Ukraine has the largest relative exchange rate risk from euro and US dollar investors’ perspective if measured by relative foreign exchange return differential. The market also shows the highest risks of USD, EUR and local currency returns. Sharpe ratio for dollar, euro and local currency for all frontier markets is calculated. It also proves that the Ukrainian market does not provide relevant returns for high risks. The average Sharpe ratio for the period is -0.29 for USD and -0.40 for EUR making Ukraine the third least attractive market in the frontier group. Correlation matrix between Ukrainian total and equity international portfolio liabilities on the one hand and four groups of indicators associated with exchange rate risk (risk, return, Sharpe ratio and relative foreign exchange return differential – all for EUR, USD and local currencies) on the other is developed. Correlations are small and medium showing that these are not the only factors influencing portfolio inflows. It is detected that pairs with risk and relative foreign exchange return differentials have the strongest correlations while the latter affecting equity liabilities and almost not influencing total liabilities. It is proved that frontier markets group represents substantial exchange rate risk for foreign investors. The relative differentials are -1.36 and -0.48 for USD and EUR investors respectively. Exchange rate risks from euro investors’ perspective are much lower than from the perspective of an US dollar investor. The FM index has the lowest USD and EUR risks representing a more efficient investment when investors diversify.
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