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HOW A SINGLE-FACTOR CAPM WORKS IN A MULTI-CURRENCY WORLD

Published online by Cambridge University Press:  23 December 2015

Robert Thomson ,
Şule Şahin  and
Taryn Reddy
Robert Thomson*
Affiliation:
School of Statistics and Actuarial Science, University of the Witwatersrand, Private Bag 3, WITS 2050, South Africa, Tel: +27-11-646 5332, Fax: +27-11-7176285
Şule Şahin
Affiliation:
Department of Actuarial Sciences, Hacettepe University, Ankara, Turkey Tel.: +90-312-297-6160 E-Mail: sule@hacettepe.edu.tr
Taryn Reddy
Affiliation:
School of Statistics and Actuarial Science, University of the Witwatersrand, Private Bag 3, WITS 2050, South Africa Tel: +27-11-717-6268, Fax: +27-11-717 6285 E-Mail: taryn.reddy@wits.ac.za
*
E-Mail: rthomson@icon.co.za
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Abstract

In this paper, a single-factor multi-currency (SFM) capital-asset pricing model (SFM-CAPM) is developed. The advantage in using a single-factor model is that it does not treat currency risks as carrying different weight from investment risks; regardless of its source, risk is measured as variance, and weighted accordingly. The aim of this paper is primarily to give actuaries a way ahead in the use of the single-factor CAPM in a multi-currency world for the purposes of the stochastic modelling of the assets and liabilities of long-term financial institutions, such as pension funds, particularly for the purposes of liability-driven investments and market-consistent valuation, and the application of the model has been designed with that intention. However, it is envisaged that the model will also be of interest to other practitioners. The paper's major original contribution to the literature is its proof that, for a single-factor CAPM to work in a multi-currency world, there is a necessary condition. The theory is applied to two major currencies and two minor currencies, namely the US dollar, the UK pound, the South African rand and the Turkish lira.

Keywords

International CAPMsingle-factor multi-currency CAPM (SFM-CAPM)

Information

Type
Research Article
Information
ASTIN Bulletin: The Journal of the IAA , Volume 46 , Issue 1 , January 2016 , pp. 103 - 139
Copyright
Copyright © Astin Bulletin 2015 

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