Hedging Foreign Exchange Risk - An Evaluation of the Optimal Hedge Ratio Determined by VaR
(2011) NEKM07 20111Department of Economics
- Abstract
- The purpose of this study is to examine the optimal hedge ratio for the currency exposure of foreign investments. The optimal hedge ratio is determined after evaluating our portfolios from the three perspectives; ex-ante, ex-post and profit/loss. The ex-ante perspective is examined by the usage of historical simulation to calculate VaR on 11 portfolio pairs. Each pair consists of a portfolio with the total investment and its hedges, and the other portfolio consisting of only the hedges. The ex-post perspective is used in order to evaluate the accuracy of these VaR estimates, measured in number of violations. The return of the hedging portfolio, which only contains the hedges, is measured in terms of profit/loss. This is given by the... (More)
- The purpose of this study is to examine the optimal hedge ratio for the currency exposure of foreign investments. The optimal hedge ratio is determined after evaluating our portfolios from the three perspectives; ex-ante, ex-post and profit/loss. The ex-ante perspective is examined by the usage of historical simulation to calculate VaR on 11 portfolio pairs. Each pair consists of a portfolio with the total investment and its hedges, and the other portfolio consisting of only the hedges. The ex-post perspective is used in order to evaluate the accuracy of these VaR estimates, measured in number of violations. The return of the hedging portfolio, which only contains the hedges, is measured in terms of profit/loss. This is given by the difference between the forward rate and the spot rate at maturity over a one-month period. We find that a 100 percent currency hedge is the most optimal portfolio ex-ante and a 30 percent hedge is the most optimal ex-post. From a return point of view, there is no optimal portfolio since we get a negative result on all of the three currencies. We conclude that there is no optimal portfolio from both a return and a risk perspective. The optimal portfolio is thus given by the investors attitude towards risk. (Less)
Please use this url to cite or link to this publication:
http://lup.lub.lu.se/student-papers/record/1976131
- author
- Fredriksson, Kim and Johansson, Carina
- supervisor
- organization
- course
- NEKM07 20111
- year
- 2011
- type
- H2 - Master's Degree (Two Years)
- subject
- keywords
- VaR, Foreign Exchange Hedging, Optimal Hedge Ratio, Forward Contracts, Historical Simulation
- language
- English
- id
- 1976131
- date added to LUP
- 2011-06-17 12:29:30
- date last changed
- 2011-06-17 12:29:30
@misc{1976131, abstract = {{The purpose of this study is to examine the optimal hedge ratio for the currency exposure of foreign investments. The optimal hedge ratio is determined after evaluating our portfolios from the three perspectives; ex-ante, ex-post and profit/loss. The ex-ante perspective is examined by the usage of historical simulation to calculate VaR on 11 portfolio pairs. Each pair consists of a portfolio with the total investment and its hedges, and the other portfolio consisting of only the hedges. The ex-post perspective is used in order to evaluate the accuracy of these VaR estimates, measured in number of violations. The return of the hedging portfolio, which only contains the hedges, is measured in terms of profit/loss. This is given by the difference between the forward rate and the spot rate at maturity over a one-month period. We find that a 100 percent currency hedge is the most optimal portfolio ex-ante and a 30 percent hedge is the most optimal ex-post. From a return point of view, there is no optimal portfolio since we get a negative result on all of the three currencies. We conclude that there is no optimal portfolio from both a return and a risk perspective. The optimal portfolio is thus given by the investors attitude towards risk.}}, author = {{Fredriksson, Kim and Johansson, Carina}}, language = {{eng}}, note = {{Student Paper}}, title = {{Hedging Foreign Exchange Risk - An Evaluation of the Optimal Hedge Ratio Determined by VaR}}, year = {{2011}}, }