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Hedging with mismatched currencies
Author(s) -
Broll Udo,
Wong Kit Pong
Publication year - 1999
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/(sici)1096-9934(199912)19:8<859::aid-fut1>3.0.co;2-a
Subject(s) - hedge , foreign exchange risk , currency , economics , interest rate parity , cash flow , foreign exchange , exchange rate , monetary economics , financial economics , foreign exchange market , forward contract , futures contract , finance , ecology , biology
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