TITLE:
Optimal Foreign Exchange Risk Hedging: A Mean Variance Portfolio Approach
AUTHORS:
Yun-Yeong Kim
KEYWORDS:
Foreign Exchange; Risk; Optimal Hedging; Closed Form
JOURNAL NAME:
Theoretical Economics Letters,
Vol.3 No.1,
February
26,
2013
ABSTRACT: This paper introduces the optimal foreign exchange risk hedging
model following a standard portfolio theory. The results indicate that a lower
level of risk can be achieved, given a specified level of expected return, from
using optimization modeling. In the paper the expected hedging return is
defined from the expected cost of the foreign currency using a specified
hedging strategy minus the expected cost of the foreign currency when it is
purchased form the spot market. The focal point of the technique is its ability
to identify optimal combinations of hedging vehicles, those are currency
options, forward contracts, leaving the position open (foreign exchange risk hedging
tools suggested by the US. Department of Commerce) in a closed form.