Applications of FX Derivatives in Active Currency Risk Management

Abstract

Risk managers exhibit heterogeneous behavior as well as shortfall aversion, money illusion, and regret risk when managing portfolio risks. Foreign exchange options provide a flexible risk/return profile that is more likely to achieve such specific investment as well as behavioral objectives. We showcase five practical applications for international currency managers in selecting the appropriate hedging and active strategies for portfolio risk management. These solutions address a wide range of behavioral needs such as regret risk, shortfall aversion, positive skewness, and the increasing need for non-monetary satisfaction in the form of well-being utility.