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Hedging with mismatched currencies

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  • Udo Broll
  • Kit Pong Wong

Abstract

This article presents a model of a risk‐averse multinational firm facing risk exposure to a foreign currency cash flow. Forward markets do not exist between the firm's own currency and the foreign currency, but do exist for a third currency. Because a triangular parity condition holds among these three currencies, the available forward markets, albeit incomplete, provide a useful avenue for the firm to indirectly hedge against its foreign exchange rate risk exposure. This article offers analytical insights into the optimal cross‐hedging strategies of the firm. In particular, the results show that separate unbiasedness of the forward markets does not necessarily imply a perfect full hedge that eliminates the entire foreign exchange rate risk exposure of the firm. The optimal cross‐hedging strategies depend largely on the firm's marginal utility function and on the correlation of the random spot exchange rates. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19:859–875, 1999

Suggested Citation

  • Udo Broll & Kit Pong Wong, 1999. "Hedging with mismatched currencies," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 19(8), pages 859-875, December.
    • Handle: RePEc:wly:jfutmk:v:19:y:1999:i:8:p:859-875
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    Cited by:

    1. Mark T. Leung & An-Sing Chen, 2005. "Performance evaluation of neural network architectures: the case of predicting foreign exchange correlations," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 24(6), pages 403-420.
    2. Kit Pong Wong, 2015. "Export And Hedging Decisions Under Correlated Revenue And Exchange Rate Risk," Bulletin of Economic Research, Wiley Blackwell, vol. 67(4), pages 371-381, October.
    3. Kit Pong Wong, 2007. "Optimal Export And Hedging Decisions When Forward Markets Are Incomplete," Bulletin of Economic Research, Wiley Blackwell, vol. 59(1), pages 67-81, January.
    4. Gurmeet Singh, 2017. "Estimating Optimal Hedge Ratio and Hedging Effectiveness in the NSE Index Futures," Jindal Journal of Business Research, , vol. 6(2), pages 108-131, December.

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