Abstract
In this paper, we consider a risk averse competitive firm that adopts currency futures and options for hedging purpose. Based on the assumption of unbiased markets of currency futures and options, we propose the optimal hedging model in dynamic setting. By using two-stage optimization method, we prove that it is desirable for the prudent enterprise to buy exchange rate options to hedge currency risk. Furthermore, we derive the closed-form solutions of the multiperiod hedging problem with the quadratic utility function. We investigate an empirical study incorporated into GARCH-t prediction on the efficiency of hedging with currency futures and options. The empirical results demonstrate that hedging with currency futures and options can reduce the silver export firm’s risk exposure. Profits and the effective boundaries are compared in three cases: hedging with futures and options synchronously, only with futures and without any hedge. The results of multiple comparisons among different hedging strategies show that hedging with linear and nonlinear derivatives is advisable for the export firm.
Highlights
Since 2005, China has begun to carry out exchange rate reform, from a single fixed exchange rate system pegged to the US dollar to a floating exchange rate system with reference to a package of currencies
The study above is to establish the optimal hedging model of exchange rate futures and options in one-stage, while, in actual hedging practice, the enterprise has to adjust the positions dynamically according to the market conditions so as to maximize its utility based on the final wealth
The major role of financial markets enabling firms to reduce price or currency risks is their impact on production and export levels
Summary
Since 2005, China has begun to carry out exchange rate reform, from a single fixed exchange rate system pegged to the US dollar to a floating exchange rate system with reference to a package of currencies. Their study provides a theoretical basis for options hedging with multiple delivery prices Since both exchange rate futures and options can be used as risk hedging tools, some scholars have conducted comparative studies on the hedging effects between the two derivatives. Wong [19] studied the optimal hedging and decision-making problem of the competitive export enterprises that faced the exchange rate risk. They proved that there were two different sources of nonlinear risk, wherein one was the multiplicative property of the price and exchange rate, and another was the nonlinear marginal utility function.
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