Dynamic Currency Futures and Options Hedging Model

Abstract

In this paper, we consider a risk averse competitive firm that adopts currency futures and options for hedging purpose. Based on the assumption of unbiased markets of currency futures and options, we propose the optimal hedging model in dynamic setting. By using two-stage optimization method, we prove that it is desirable for the prudent enterprise to buy exchange rate options to hedge currency risk. Furthermore, we derive the closed-form solutions of the multiperiod hedging problem with the quadratic utility function. We investigate an empirical study incorporated into GARCH-t prediction on the efficiency of hedging with currency futures and options. The empirical results demonstrate that hedging with currency futures and options can reduce the silver export firm’s risk exposure. Profits and the effective boundaries are compared in three cases: hedging with futures and options synchronously, only with futures and without any hedge. The results of multiple comparisons among different hedging strategies show that hedging with linear and nonlinear derivatives is advisable for the export firm.