Post by Sapphire Capital on Jul 16, 2008 6:09:07 GMT 4
Inverse Currency Futures Hedging
ERIC TERRY
Ryerson University March 3, 2007
Abstract:
We examine the problem of hedging a foreign exchange exposure when a futures contract on the foreign currency does not exist but there is does exist a futures contract on the value of the local currency in terms of the foreign currency. This situation is termed inverse currency futures hedging. A general formula for the inverse currency futures hedge ratio is derived and compared to the corresponding formula for direct currency hedging. Special cases of this formula are obtained for commonly-made assumptions about the joint spot and futures price process. The inverse currency futures hedging formula is also extended to incorporate quantity risk, i.e., cases in which the amount of foreign exchange risk to which a firm will be exposed in the future is not known with certainty. Empirically, the inverse currency futures hedge is found to provide similar risk reduction as what can be achieved under direct hedging. As well, the performance of the inverse hedge does not appear to depend heavily on the choice of inverse hedging model.
papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1102541_code945165.pdf?abstractid=1102541&mirid=2
ERIC TERRY
Ryerson University March 3, 2007
Abstract:
We examine the problem of hedging a foreign exchange exposure when a futures contract on the foreign currency does not exist but there is does exist a futures contract on the value of the local currency in terms of the foreign currency. This situation is termed inverse currency futures hedging. A general formula for the inverse currency futures hedge ratio is derived and compared to the corresponding formula for direct currency hedging. Special cases of this formula are obtained for commonly-made assumptions about the joint spot and futures price process. The inverse currency futures hedging formula is also extended to incorporate quantity risk, i.e., cases in which the amount of foreign exchange risk to which a firm will be exposed in the future is not known with certainty. Empirically, the inverse currency futures hedge is found to provide similar risk reduction as what can be achieved under direct hedging. As well, the performance of the inverse hedge does not appear to depend heavily on the choice of inverse hedging model.
papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1102541_code945165.pdf?abstractid=1102541&mirid=2