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Enhancing returns on yen: minimizing risk reversal costs

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  • David VanderLinden
  • Kristijan Nikolov

Abstract

Cash managers and other investors with excess Japanese yen could choose to invest in dollars and to use zero-cost currency options collars (or risk reversals) to limit fluctuations in the dollar-yen exchange rate (as illustrated by VanderLinden and Gramlich, 2005). However, traders know that there is a market-driven, time-varying cost to risk reversals that can reduce their effectiveness in hedging. This paper evaluates a decision rule to reduce the impact of risk reversal costs. This rule, based on a 30-day moving average of risk reversal costs, appears to minimize risk reversal costs when used with the dollar-yen exchange rate. Whether application of the rule significantly improves risk-adjusted returns is less clear.

Suggested Citation

  • David VanderLinden & Kristijan Nikolov, 2005. "Enhancing returns on yen: minimizing risk reversal costs," Applied Financial Economics, Taylor & Francis Journals, vol. 15(17), pages 1203-1211.
    • Handle: RePEc:taf:apfiec:v:15:y:2005:i:17:p:1203-1211
    DOI: 10.1080/09603100500387410
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    References listed on IDEAS

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    3. Antonio E. Bernardo & Olivier Ledoit, 2000. "Gain, Loss, and Asset Pricing," Journal of Political Economy, University of Chicago Press, vol. 108(1), pages 144-172, February.
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