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; exante, expost and profit/loss. The exante 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 expost 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; exante, expost and profit/loss. The exante 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 expost 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 onemonth period. We find that a 100 percent currency hedge is the most optimal portfolio exante and a 30 percent hedge is the most optimal expost. 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/studentpapers/record/1976131
 author
 Fredriksson, Kim and Johansson, Carina
 supervisor

 Birger Nilsson ^{LU}
 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
 20110617 12:29:30
 date last changed
 20110617 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; exante, expost and profit/loss. The exante 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 expost 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 onemonth period. We find that a 100 percent currency hedge is the most optimal portfolio exante and a 30 percent hedge is the most optimal expost. 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}, keyword = {VaR,Foreign Exchange Hedging,Optimal Hedge Ratio,Forward Contracts,Historical Simulation}, language = {eng}, note = {Student Paper}, title = {Hedging Foreign Exchange Risk  An Evaluation of the Optimal Hedge Ratio Determined by VaR}, year = {2011}, }