Optimal Hedging of Currency Exchange Risk Exposure

[Sapphire Capital]

Optimal Hedging of the Currency Exchange Risk Exposure of Dynamically Balanced Strategic Asset Allocations

Nikolaus Hautsch
Humboldt-Universität zu Berlin; CASE - Center for Applied Statistics and Economics; CFS; QPL

Joachim Inkmann
Tilburg University



Journal of Asset Management, Vol. 4, No. 3, pp. 173-198

Abstract:
This paper presents theoretical and empirical results on the magnitude of optimal hedge ratios for a dynamically balanced strategic asset allocation with multiple currencies. Optimality refers to a mean-variance objective function with a time-varying risk-aversion parameter. A data driven choice of this parameter is proposed, which is suggested by a Sharpe ratio maximization criterion and renders the vector of optimal hedge ratios scale invariant. Empirical results are given for an EMU based investor with USD, GBP and JPY assets and an US based investor with assets in EUR, GBP and JPY. Since the vector of optimal hedge ratios depends on the conditional variance-covariance matrix of the involved exchange rate return time series, multivariate GARCH models are estimated. In particular, ML estimation of the DCC-GARCH model is performed, which remains computationally attractive in large dimensional cases. A fixed-mix rebalancing investment rule is applied in order to maintain the strategic asset allocation over time. Finally, hedging strategies for subsidiary companies are investigated, which account for the hedging interests of their mother company.

papers.ssrn.com/sol3/papers.cfm?abstract_id=1292526

[John]

Can you post something of your own? Your own comments or your own article?

[Sapphire Capital]

The paper was posted as an abstract to send people who may be interested in the topic for research to the source, the reason is that otherwise this paper as others will not be read because it is not seen. I sure have an opinion on hedging forex positions and do it all the time since I believe forex trading without a hedge is a game of luck, looking for luck in a forex situation is not really what I would say is good business sense, especially when our positions as a partnership are not for profit but to minimize exposure to fluctuation risk, sure there is an occassional profit and even some high but also loss but it never reaches the catastrophal some small investors face when not hedging. Forex is actually needed in all international portfolios but I found our traders not reading the theoretical papers and concentrating on more short term lived news; not that it is wrong but I like to see a base knowledge in people engaging in the market.