Hostname: page-component-848d4c4894-nmvwc Total loading time: 0 Render date: 2024-07-05T22:10:46.915Z Has data issue: false hasContentIssue false
  • English
  • Français

Cross-Hedging with Currency Options and Futures

Published online by Cambridge University Press:  06 April 2009

Eric C. Chang  and
Kit Pong Wong
Eric C. Chang
Affiliation:
ecchang@business.hku.hk, School of Business
Kit Pong Wong
Affiliation:
kpwong@econ.hku.hk, School of Economics and Finance, University of Hong Kong, Pokfulam Road, Hong Kong.
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper develops an expected utility model of a multinational firm facing exchange rate risk exposure to a foreign currency cash flow. Currency derivative markets do not exist between the domestic and foreign currencies. There are, however, currency futures and options markets between the domestic currency and a third currency to which the firm has access. Since a triangular parity condition holds among these three currencies, the available, yet incomplete, currency futures and options markets still provide a useful avenue for the firm to indirectly hedge against its foreign exchange risk exposure. This paper offers analytical insights into the optimal cross-hedging strategies of the firm. In particular, the results show the optimality of using options in conjunction with futures in the case of currency mismatching, even though cash flows appear to be linear.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 38 , Issue 3 , September 2003 , pp. 555 - 574
Copyright
Copyright © School of Business Administration, University of Washington 2003

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Benninga, S., and Blume, M. E.. “On the Optimality of Portfolio Insurance.” Journal of Finance, 40 (1985), 1341–1352.CrossRefGoogle Scholar
Black, F., and Scholes, M. J.. “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy, 81 (1973), 637–659.CrossRefGoogle Scholar
Bodnar, G. M., and Gebhardt, G.. “Derivatives Usage in Risk Management by U.S. and German Non-Financial Firms: A Comparative Survey.” Journal of International Financial Management and Accounting, 10 (1999), 153–187.CrossRefGoogle Scholar
Bodnar, G. M.; Hayt, G.; and Marston, R. C.. “1995 Wharton Survey of Derivative Usage by U.S. Non-Financial Firms.” Financial Management, 25 (1996), 113–133.CrossRefGoogle Scholar
Bodnar, G. M.; Hayt, G.; and Marston, R. C.. “1998 Wharton Survey of Financial Risk Management by U.S. Non-Financial Firms.” Financial Management, 27 (1998), 70–91.CrossRefGoogle Scholar
Brennan, M. J., and Solanki, R.. “Optimal Portfolio Insurance.” Journal of Financial and Quantitative Analysis, 16 (1981), 279–300.CrossRefGoogle Scholar
Dr`èze, J. H., and Modigliani, F.. “Consumption Decisions under Uncertainty.” Journal of Economic Theory, 5 (1972), 308–335.CrossRefGoogle Scholar
Duffie, D., and Richardson, H. R.. “Mean-Variance Hedging in Continuous Time.” Annals of Applied Probability, 1 (1991), 1–15.CrossRefGoogle Scholar
Eiteman, D. K.; Stonehill, A. I.; and Moffett, M. H.. Multinational Business Finance. Massachusetts: Addison-Wesley (1998).Google Scholar
Froot, K. A.; Scharfstein, D. S.; and Stein, J. C.. “Risk Management: Coordinating Corporate Investment and Financing Policies.” Journal of Finance, 48 (1993), 1629–1658.CrossRefGoogle Scholar
Franke, G.; Stapleton, R. C.; and Subrahmanyam, M. G.. “Who Buys and Who Sells Options: The Role of Options in an Economy with Background Risk.” Journal of Economic Theory, 82 (1998), 89–109.CrossRefGoogle Scholar
Haugh, M. B., and Lo, A. W.. “Asset Allocation and Derivatives.” Quantitative Finance, 1 (2001), 45–72.CrossRefGoogle Scholar
Jacque, L. L.Management and Control of Foreign Exchange Risk. Boston, MA: Kluwer Academic Publishers (1996).CrossRefGoogle Scholar
Kimball, M. S. “Precautionary Saving in the Small and in the Large.” Econometrica, 58 (1990), 53–73.CrossRefGoogle Scholar
Kimball, M. S. “Standard Risk Aversion.” Econometrica, 61 (1993), 589–611.CrossRefGoogle Scholar
Leland, H. E. “Saving and Uncertainty: The Precautionary Demand for Saving.” Quarterly Journal of Economics, 82 (1968), 465–473.CrossRefGoogle Scholar
Leland, H. E. “Who Should Buy Portfolio Insurance.” Journal of Finance, 35 (1980), 581–594.CrossRefGoogle Scholar
Meese, R. “Currency Fluctuations in the Post-Bretton Woods Era.” Journal of Economic Perspectives, 4 (1990), 117–134.CrossRefGoogle Scholar
Rawls, S. W., and Smithson, C. W.. “Strategic Risk Management.” Journal of Applied Corporate Finance, 1 (1990), 6–18.CrossRefGoogle Scholar
Sercu, P., and Uppal, R.. International Financial Markets and the Firm. Cincinnati, OH: South-Western College Publishing (1995).Google Scholar
Smith, C.W., and Stulz, R.. “The Determinants of Firms' Hedging Policies.” Journal of Financial and Quantitative Analysis, 20 (1985), 391–405.CrossRefGoogle Scholar
Stulz, R. “Optimal Hedging Policies.” Journal of Financial and Quantitative Analysis, 19 (1984), 127–140.CrossRefGoogle Scholar
Stulz, R. “Managerial Discretion and Optimal Financial Policies.” Journal of Financial Economics, 26 (1990), 3–27.CrossRefGoogle Scholar
Tufano, P. “Who Manages Risk? An Empirical Examination of Risk Management Practices in the Gold Mining Industry.” Journal of Finance, 51 (1996), 1097–1137.CrossRefGoogle Scholar