Exchange Rate Risk Exposure to Kenya's External Public Debt Portfolio and the Economic Policy Options

Abstract

Kenya's public debt stock has been growing at a higher rate. If the risk contingent in the Public external debt escalates then the country might be sunk in a debt crisis. To avoid this kind of problem this study analyses the currency composition of the Kenya external debt stock to show the currency that generates most risk. The paper then provides economic policy options for the decision makers. The empirical study analyses the exchange rate risk associated with the four major currencies, the Euro, the US Dollar, the Japanese Yen and the Sterling pound on the Kenya external public debt portfolio. The paper uses the Value at Risk methodology for the period January 1993 to June 2013. We show on this paper that for daily data, the optimal length of time to authenticate the normality assumption is one year (annual). The paper concludes that Kenya's external public debt has no hedging strategy and is therefore severely exposed to the exchange rate volatility. This is evident from the fact that none of the exchange rate returns have a negative beta. There is no refuge currency to help manage the exchange rate risk volatility. The marginal VaR reveals that the US Dollar is the least risky currency and the Japanese Yen as the most risky currency in the external public debt portfolio. This is also confirmed in Markowitz risk return analysis and the systematic risk analysis. Finally the VaR analysis indicates that the portfolio is exposed and is defenseless when the exchange rate swings occur.