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Cross‐Hedging of Exchange‐Rate Risk
Author(s) -
Broll Udo,
Eckwert Bernhard
Publication year - 1996
Publication title -
review of international economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.513
H-Index - 58
eISSN - 1467-9396
pISSN - 0965-7576
DOI - 10.1111/j.1467-9396.1996.tb00104.x
Subject(s) - hedge , economics , foreign exchange risk , exchange rate , currency , forward contract , financial economics , market neutral , monetary economics , econometrics , futures contract , ecology , biology , portfolio
For currencies with highly developed forward markets a well‐known separation theorem holds which implies that international firms fully hedge the exchange rate risk if the forward markets are unbiased. In this paper we present a model of a risk‐averse firm when perfect hedging instruments are not available. Instead the firm can cross‐hedge the exchange‐rate risk by using the forward markets of a third country's currency. We demonstrate that the unbiasedness of all forward markets does not imply full hedge, although the firm has the option to hedge all the risks.