The tail index of exchange rate returns

Abstract

In the literature on the empirical distribution of foreign exchange rates there is now consensus that exchange rate yields are fat-tailed. Three problems, however, persist: (1) Which class of distribution functions is most appropriate? (2) Are the parameters of the distribution invariant over subperiods? (3) What are the effects of aggregation over time on the distribution? In this paper we employ extreme value theory to shed new light on these questions. We apply the theoretical results to EMS data.*We wish to thank Laurens de Haan for his invaluable theoretical insights. Guido Imbens, Peter Schotman, an anonymous referee and the editors of this journal provided valuable comments. Ieko Sevinga provided able research assistance. We profited from presentations given at Brown University, the University of Zurich and the European Economic Association meetings 1988. The major part of this work was conducted while all three authors were at Erasmus University Rotterdam.'The survey by Boothe and Glassman gives the state of the art in modelling the exchange rate yield distribution. Therefore we deem it unnecessary to provide an exegesis of the existing literature. Rather, for each issue we discuss, we refer to the corresponding discussion in Boothe and Glassman. Thus, the reader should bear in mind that this is not a critique, but a continuation. Our approach, though, is quite novel. 0022-1996/90/%03.50 0 1990-Elsevier Science Publishers B.V. (North-Holland) J.I.E. D

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