Hedging Foreign Exchange Exposure: Risk Reduction from Transaction and Translation Hedging

Hedging Demand and Foreign Exchange Risk Premia

This paper develops and tests a model of unobservable risk premia in the foreign exchange market. Risk premia in our model are driven by non-marketable income shocks which risk averse agents attempt to hedge by trading foreign currency. We test our model using data on hedging demand in currency futures and find that our proxy for risk premia explains approximately 45 percent of the variation in...

Option Hedging with Transaction Costs

What lies beneath: Foreign exchange rate exposure, hedging and cash flows

This paper presents results from an in-depth analysis of the foreign exchange rate exposure of a large nonfinancial firm based on proprietary internal data including cash flows, derivatives and foreign currency debt, as well as external capital market data. While the operations of the multinational firm have significant exposure to foreign exchange rate risk due to foreign currency-based activi...

Optimal Hedging of Stock Portfolios against Foreign Exchange Risk: Theory and Applications

This paper applies a formula for the optimal hedge in a mean-variance framework to an investment in the Nikkei 225. It is shown that through hedging U.S. investors can construct a portfolio long in the Nikkei whose dollar excess return has the same volatility as the yen excess return of the Nikkei. There seems to be little gain from improving estimates of the exposure of the Nikkei to the dolla...

Small transaction cost asymptotics and dynamic hedging

Transaction costs are one of the major impediments to the implementation of dynamic hedging strategies. We consider an alternative to utility maximization, similar to the “good-deal” pricing framework in incomplete markets. We perform a dynamic riskreward analysis for a family of non-self-financing strategies of practical importance: deterministic time hedging; i.e., hedging at predetermined, f...