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This article addresses some of the issues related to the management and measurement of foreign exchange risk as applied to emerging markets. It is, however, just as relevant to any asset classes and asset managers with nonnormal distribu- tions, particularly those with fat tails such as hedge funds.

Key findings:

• The measurement and management of foreign exchange (FX) risk, particularly in emerging market portfolios, often is not fully understood.
• The most common approach to measurement and management of Currency risk is Value-at-Risk (VaR) analysis.
• VaR is a powerful tool and it encompasses a great deal of important information, but it should not be the end of the risk management story.
• Explicit tail risk needs to be measured and monitored.
• It is strongly recommended that investors consider using explicit risk parameters that measure uncorrelated VaR, where clustering phenomenon may break down long-term correlation relationships.
• Investors also need to carefully assess liquidity constraints, and limits should specifically be put in place to limit exposure to illiquid currencies and assets (with obvious impacts on capacity).
• It is sensible to proactively monitor and manage tail risk and adjust appropriately to account for this risk.
• A manager may have an exceptional Sharpe ratio with limited drawdowns but still have significant tail risk inherent in the distributi......................

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