Computing Currency Invariant Indices with an Application to Minimum Variance Currency Baskets

24 Pages Posted: 10 Apr 2008

See all articles by Nikolai V. Hovanov

Nikolai V. Hovanov

Saint Petersburg State University

James W. Kolari

Texas A&M University - Department of Finance

Mikhail V. Sokolov

Saint Petersburg State University; European University at St. Petersburg (EUSP) - Department of Economics; Russian Academy of Sciences (RAS) - Saint Petersburg Institute for Economics and Mathmatics

Abstract

This paper provides an exact and computable invariant currency value index (ICVI) which is independent of base currency choice. Thus, given a 1xed set of currencies, the index of a currency will have the same value, regardless of base currency choice. This currency index can be used as an indicator to assess movements of an individual currency's value in world currency markets. The methodological and mathematical reasoning behind ICVI is formulated in terms of a simple exchange model (SIMEX).

To demonstrate one possible application we employ ICVI to construct a currency basket of minimum variance. Utilizing a quadratic optimization framework, we compute optimal weights for currencies and construct a stable aggregate currency (SAC). Comparative empirical analyses of a 1ve-currency SAC and the IMF's Special Drawing Rights (SDR) demonstrates that the SAC has lower volatility and lower correlations with its components than the SDR. In a similar way it is shown that a three-currency SAC has a smaller variance than the world money basket proposed by R. Mundell. Numerous academic and business implications are possible for further study with the use of the indices ICVI and SAC.

Keywords: Currency index, Currency basket, Minimal variance, Numeraire, International 1nance, World money

JEL Classification: C43, C61, C63, D81, F31, F33, G11, G15

Suggested Citation

Hovanov, Nikolai V. and Kolari, James W. and Sokolov, Mikhail V., Computing Currency Invariant Indices with an Application to Minimum Variance Currency Baskets. Journal of Economic Dynamics and Control, Vol. 28, pp. 1481-1504, 2004. Available at SSRN: https://ssrn.com/abstract=1118561

Nikolai V. Hovanov (Contact Author)

Saint Petersburg State University ( email )

198904, Bibliotechnaya sq.2
Faculty of Economics
St. Petersburg
Russia
+7(812)164-2937 (Phone)
+7(812)164-4136 (Fax)

James W. Kolari

Texas A&M University - Department of Finance ( email )

MS-4218
Department of Finance
College Station, TX TX 77843-4218
United States
979-845-4803 (Phone)
979-845-3884 (Fax)

Mikhail V. Sokolov

Saint Petersburg State University ( email )

7-9, Universitetskaya nab.
Saint Petersburg, 199034
Russia

European University at St. Petersburg (EUSP) - Department of Economics

3 Gagarinskaya Street
St. Petersburg, 191187
Russia

Russian Academy of Sciences (RAS) - Saint Petersburg Institute for Economics and Mathmatics ( email )

Tchaikovsky st. 1
Saint Petersburg, 191187
Russia

Register to save articles to
your library

Register

Paper statistics

Downloads
148
Abstract Views
990
rank
195,300
PlumX Metrics