Currency risk management: simulating the Canadian dollar

Abstract

PurposeThe purpose of this article is to investigate the return associated with a Canadian dollar (C$) investment in the USA under passive, random walk, value at risk, and Sharpe ratio strategies.Design/methodology/approachTo comply with the purpose, this paper used a GARCH model, and used, as basic data, daily C$ exchange rates and weekly US and Canadian interest rates on 90‐day CDs, from January 2 to November 26, 2004.FindingsThe empirical results suggest that currency returns are positively correlated to risk; and that the return provided by the random walk strategy beats the other strategies considered in this paper.Practical implicationsThe findings suggest that currency investment is similar to other forms of investment, since it shows a positive relationship between risk and return. It also supports the long‐standing belief that sophisticated strategies do not beat simple‐minded approaches such as a random walk strategy.Originality/valueThis paper uses a utility function to investigate the response of investors to risk and return under different aversion scenarios.