Currency Hedging Strategies Research Articles

Currency Hedging Strategies Using Dynamic Multivariate GARCH

This paper examines the effectiveness of using futures contracts as hedging instruments of: (1) alternative models of volatility for estimating conditional variances and covariances; (2) alternative currencies; and (3) alternative maturities of futures contracts. For this purpose, daily data of futures and spot exchange rates of three major international currencies, Euro, British pound and Japanese yen, against the American dollar, are used to analyze hedge ratios and hedging effectiveness resulting from using two different maturity currency contracts, near-month and next-to-near-month contract. Following Chang et al. [17], we estimate four multivariate volatility models (namely CCC, VARMA-AGARCH, DCC and BEKK), and calculate optimal portfolio weights and optimal hedge ratios to identify appropriate currency hedging strategies. The hedging effectiveness index suggests that the best results in terms of reducing the variance of the portfolio are for the USD/GBP exchange rate. The empirical results show that futures hedging strategies are slightly more effective when the near-month future contract is used for the USD/GBP and USD/JPY currencies. Moreover, the CCC and AGARCH models provide similar hedging effectiveness, which suggests that dynamic asymmetry may not be crucial empirically, although some differences appear when the DCC and BEKK models are used.

动态避险模型之建立—以远期外汇与一篮子货币避险策略为例

本研究建构一动态避险模型，由传统避险工具与一篮子货币避险策略所构成。由于传统避险工具的好处在于风险的完全规避，而一篮子货币避险之主要目的则在于降低避险成本，因此本研究之动态避险模型，系以一篮子货币避险策略为主，于每期期初比较两种策略之避险成本，择其低者作为该期之避险策略。另外，为建立更为精确的一篮子货币避险部位，本研究亦导入人工智能工具于模型中，试图利用人工智能于汇率预测上的优秀表现，优化篮子内货币之权重，进而达到更佳的避险绩效。经实证，本研究之动态避险模型，确能显着地优于仅执行单一传统避险工具或者一篮子货币避险策略。其中，以两年作为权重估计期间并纳入预测技术之模型，于实验期间内表现最佳，是为本研究所推荐使用之模型。 This paper proposes a “dynamic hedging model”, which adjusts the hedging strategies by the time, to increase the hedging performance. The dynamic hedging model is combined with the traditional hedging strategy (e.g. Delivery Forward) and the basket currency hedging. The traditional hedging strategy covers the whole risk, in the mean time, the basket currency reduce the hedging cost. Therefore, we establish the position of basket currency first, and execute this strategy when its hedging cost is lower than the traditional hedging strategy; otherwise, we execute the traditional hedging strategy. Besides, for establishing a more precise position of basket currency, we also use artificial intelligence to forecast the exchange rate, which is expected to estimate the currency weight in a basket more precisely. Empirically, the dynamic hedging model we propose performs much better than either the traditional hedging strategy or basket currency hedging strategy. In addition, due to the way of using two-year estimation period and adding forecast technology to correct the estimation got the best performance, we recommend this model to be a reference of a company’s hedging behavior.

Currency Hedging Strategies of Non-Financial Firms in Thailand

Currency Hedging Strategies of Non-Financial Firms in Thailand

动态避险模型之建立—以远期外汇与一篮子货币避险策略为例The Dynamic Hedging Model —A Combination of Delivery Forward and Currency Basket Hedge

本研究建构一动态避险模型，由传统避险工具与一篮子货币避险策略所构成。由于传统避险工具的好处在于风险的完全规避，而一篮子货币避险之主要目的则在于降低避险成本，因此本研究之动态避险模型，系以一篮子货币避险策略为主，于每期期初比较两种策略之避险成本，择其低者作为该期之避险策略。另外，为建立更为精确的一篮子货币避险部位，本研究亦导入人工智能工具于模型中，试图利用人工智能于汇率预测上的优秀表现，优化篮子内货币之权重，进而达到更佳的避险绩效。经实证，本研究之动态避险模型，确能显着地优于仅执行单一传统避险工具或者一篮子货币避险策略。其中，以两年作为权重估计期间并纳入预测技术之模型，于实验期间内表现最佳，是为本研究所推荐使用之模型。 This paper proposes a “dynamic hedging model”, which adjusts the hedging strategies by the time, to increase the hedging performance. The dynamic hedging model is combined with the traditional hedging strategy (e.g. Delivery Forward) and the basket currency hedging. The traditional hedging strategy covers the whole risk, in the mean time, the basket currency reduce the hedging cost. Therefore, we establish the position of basket currency first, and execute this strategy when its hedging cost is lower than the traditional hedging strategy; otherwise, we execute the traditional hedging strategy. Besides, for establishing a more precise position of basket currency, we also use artificial intelligence to forecast the exchange rate, which is expected to estimate the currency weight in a basket more precisely. Empirically, the dynamic hedging model we propose performs much better than either the traditional hedging strategy or basket currency hedging strategy. In addition, due to the way of using two-year estimation period and adding forecast technology to correct the estimation got the best performance, we recommend this model to be a reference of a company’s hedging behavior.

Active Currency Hedging Strategies for Global Equity Portfolios

His article examines, for 21 developed countries, whether active currency hedging strategies can outperform currency benchmarks: 100% unhedged, 50%/50%, and 100% hedged. We consider four active currency strategies: 1) the “selective” strategy that consists in hedging when the forward rate is at a premium, 2) the “large premia” strategy that consists in hedging only when the premium is large, 3) the momentum strategy, and 4) the mean-reverting strategy. Results for the 1992–2004 period show that, overall, the selective strategy outperforms the other strategies at 12- and 1-month horizons. Results for sub-periods show that no strategy continuously dominates. <b>TOPICS:</b>Global, developed, currency

Exchange rate exposure of sectoral returns and volatilities: Evidence from Japanese industrial sectors

Most studies of exchange rate exposure of stock returns do not address three relevant aspects simultaneously. They are, namely: sensitivity of stock returns to exchange rate changes; sensitivity of volatility of stock returns to volatility of changes in foreign exchange market; and the correlation between volatilities of stock returns and exchange rate changes. In this paper, we employ a bivariate GJR-GARCH model to examine all such aspects of exchange rate exposure of sectoral indexes in Japanese industries. Based on a sample data of fourteen sectors, we find significant evidence of exposed returns and its asymmetric conditional volatility of exchange rate exposure. In addition, returns in many sectors are correlated with those of exchange rate changes. We also find support for the “averaged-out exposure and asymmetries” argument. Our findings have direct implications for practitioners in formulating investment decisions and currency hedging strategies.

Hedging the exchange rate risk in international portfolio diversification

PurposeThis study seeks to examine the effectiveness of controlling the currency risk for international diversified mixed‐asset portfolios via two different hedge instruments, currency forwards and currency options. So far, currency forward has been the most common hedge tool, which will be compared here with currency options to control the foreign currency exposure risk. In this regard, several hedging strategies are evaluated and compared with one another.Design/methodology/approachOwing to the highly skewed return distributions of options, the application of the traditional mean‐variance framework for portfolio optimization is doubtful. To account for this problem, a mean lower partial moment model is employed. An in‐the‐sample as well as an out‐of‐the sample context is used. With in‐sample analyses, a block bootstrap test has been used to statistically test the existence of any significant performance improvement. Following that, to investigate the consistency of the results, the out‐of‐sample evaluation has been checked. In addition, currency trends are also taken into account to test the time‐trend dependence of currency movements and, therefore, the relative potential gains of risk‐controlling strategies.FindingsResults show that European put‐in‐the‐money options have the potential to substitute the optimally forward‐hedged portfolios. Considering the composition of the portfolio in using in‐the‐money options and forwards shows that using any of these hedge tools brings a much more diversified selection of stock and bond markets than no hedging strategy. The optimal option weights imply that a put‐in‐the‐money option strategy is more active than at‐the‐money or out‐of‐the‐money put options, which implies the dependency of put strategies on the level of strike price. A very interesting point is that, just by dedicating a very small part of the investment in options, the same amount of currency risk exposure can be hedged as when one uses the optimal forward hedging. In the out‐of‐sample study, the optimally forward‐hedged strategy generally presents a much better performance than any types of put policies.Practical implicationsThe research shows the risk and return implications of different currency hedging strategies. The finding could be of interest for asset managers of internationally diversified portfolios.Originality/valueConsidering the findings in the out‐of‐sample perspective, the optimally forward‐hedged minimum risk portfolio dominates all other strategies, while, in the depreciation of the local currency, this, together with the forward‐hedged tangency portfolio selection, would characterize the dominant portfolio strategies.

Treasury Management Model with Foreign Exchange Exposure

In this paper we formulate a model for foreign exchange exposure management and (international) cash management taking into consideration random fluctuations of exchange rates. A vector error correction model (VECM) is used to predict the random behaviour of the forward as well as spot rates connecting dollar and sterling. A two-stage stochastic programming (TWOSP) decision model is formulated using these random parameter values. This model computes currency hedging strategies, which provide rolling decisions of how much forward contracts should be bought and how much should be liquidated.The model decisions are investigated through ex post simulation and backtesting in which value at risk (VaR) for alternative decisions are computed. The investigation (a) shows that there is a considerable improvement to “spot only” strategy, (b) provides insight into how these decisions are made and (c) also validates the performance of this model.

Preference-Based Strategic Currency Hedging

This article considers the value to a given investor of volatility reduction through currency hedging relative to taking an unhedged position. Included is a decision framework to help international investors analyze how the potential risk reduction benefits of hedging interact with the investor's beliefs about the currency risk premium, risk aversion, and investment constraints to determine an optimal currency-hedging strategy. In our framework, investors choose from nine hedging strategies, each of which may be optimal under a specific set of assumptions. The article concludes that a unitary hedge strategy is best for investors who do not forecast currency returns. For those who make strategic currency-return forecasts, our aggregated results suggest an optimized hedge strategy using expected return inputs from an asset-pricing model.

International Hedge of Fixed-Income Contracts

The fixed–income literature is concerned with hedging strategies for controlling the interest rate risk of assets and liabilities held domestically in a single currency. That there is little research dedicated to international immunization may reflect a view that companies and financial institutions dealing internationally need only replicate a single–currency hedging strategy in each country. The authors argue that separate immunization in each country is overly restrictive and may be costly to execute. Instead, they propose a less restrictive strategy treating the assets and liabilities held across currencies as portfolios, and matching the duration of those portfolios. Their immunization strategy should directly reduce the cost of international hedging against interest risk, and indirectly reduce the cost of hedging against currency risk. Simulation results suggest that the proposed strategy should be at least as effective as well as cheaper to implement.

Cross-Industry and Cross-Country International Equity Diversification

This article shows that portfolios that aim to diversify across countries and across industries provide markedly better reward-to-risk ratios than the traditional asset allocation strategies that aim to select country positions and then index local broad market indexes. Country asset allocations are distinctly different under each strategy. The results hold across nationality of investors, across alternative benchmarks, and across alternative currency hedging strategies.

Global Asset Allocation

In this overview of global asset allocation opportunities, the authors tout the “three Ps:” philosophy, process, and performance. The questions they examine along the way include: the performance of global asset allocation; whether equity market correlations have been increasing; the relationship of investment horizons to the benefit of international diversification; country-industry and value-growth comparisons; and optimal currency hedging strategies. “Only by studying world equity markets in conjunction with the economic, social, and political aspects of world affairs” can portfolio managers be informed on this issue, they say.

Discrete exchange rate hedging strategies

In this paper we compare the effect of alternative currency hedging strategies on the variance of the terminal value of the firm. The main focus is on the time at which the hedge is put down and the frequency with which it is adjusted. We show that commonly used strategies, such as one-period cash flow hedges and long-term fixed hedges may leave them firm very exposed to foreign exchange risk. One possible explanation for the popularity of one-period cash flow hedges is that the firm may shift its operations in response to an exchange rate change. We argue that the opportunity for such shifts may help to explain the use of short term hedges.

Currency hedging strategies for internationally diversified equity portfolios

Currency hedging strategies for internationally diversified equity portfolios

A Simple Solution for Optimal Currency Hedging

Rather than relying on historical experience to determine the optimal currency hedging strategy for portfolios that include foreign assets, one can use a simple procedure adapted from portfolio management theory. This procedure specifies the utility of a portfolio, given the investor's risk tolerance, asset and currency returns, standard deviations, weights and covariances. The sensitivity of the portfolio's utility can then be measured as a function of currency exposure. The portfolio's exposure to each currency to which utility is related positively is increased, and its exposure to each currency to which utility is related negatively is decreased. The portfolio's exposure to the currency with the largest sensitivity (in absolute terms) is iteratively adjusted until all the portfolio's sensitivities equal zero. This currency exposure represents the optimal portfolio-the one that offers the highest return for the chosen risk level. In some special cases, the optimal hedging strategy can be determined more directly. For example, the minimum-risk strategy for a single foreign asset can be identified by measuring the currency's beta relative to the underlying portfolio. For a portfolio with several foreign assets, the minimum-risk strategy can be defined by regressing the portfolio's returns on the currencies' returns. The basic procedure can also be adjusted to take inflation into account and to incorporate liabilities.

Measuring the Effectiveness of Currency Hedging Strategies

This presentation comes from the Managing Currency Risk conference held in Boston, Massachusetts, on June 22, 1989.