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 based investor's portfolio. We use the GARCH based Value at Risk (VaR) to compute the upside and downside risk measures while the generalised Pareto distribution (GPD) method is applied 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. Moreover, we found that exchange rate risk is underestimated when using the variance-covariance method.