– The purpose of this paper is to explore the extent of the so-called “small-sample problem” within quantitative exchange-rate risk management.
– The authors take a closer look at the frequency distribution of nominal price changes in the European foreign exchange markets.
– The analysis clearly illustrates the risk of seriously underestimating the probability and magnitude of tail events when frequency distributions are derived from fairly short data samples.
– The authors suggest that financial institutions and regulators should have an eye for the long-term historical perspective when designing sensitivity tests or “worst case” scenarios in relation to risk assessments and stress tests.
– The authors add to the literature by analysing the distribution of nominal exchange-rate fluctuations on the basis of a unique quarterly data set for ten European exchange-rate pairs covering a time span of 273 years constructed by the authors. To the best of the authors' knowledge this is the first study on nominal exchange-rate changes for a large number of exchange-rate pairs based on quarterly data spanning almost three centuries.
