Currency Hedge Design: Accounting for Uncertain Correlation and Volatility

Peregrine Securities, 2015

28 Pages Posted: 23 Apr 2016

See all articles by Anthony Seymour

Anthony Seymour

University of Cape Town (UCT)

Florence Chikurunhe

Peregrine Securities

Emlyn James Flint

Legae Peresec; Department of Actuarial Science, University of Cape Town

Date Written: August 17, 2015

Abstract

In previous Peregrine Securities work, it was shown that currency hedge selection can be approached in an optimization framework and that the particular choice of hedge is strongly dependent on the correlation between the exchange rate and the foreign asset. Unfortunately, correlations between assets are generally unstable and it can be difficult to forecast an appropriate value to use as input to the optimizer. In this work we outline an approach to the determination of an optimal currency hedge in the presence of non-constant volatility and correlation. It is shown that implementation of the dynamic conditional correlation (DCC) model in a simulation framework allows one to incorporate the effects of time-varying parameters into the hedge selection process in a systematic and quantitative manner. An important finding is that the particular choice of short-term hedge depends to a large extent on the current value of correlation, emphasising the need for a modelling framework that provides accurate estimates of time-varying correlation.

Keywords: currency hedging, dynamic conditional correlation, DCC model, portfolio hedging, portfolio optimization

JEL Classification: C15, C4, C5, C32, G13

Suggested Citation

Seymour, Anthony and Chikurunhe, Florence and Flint, Emlyn James, Currency Hedge Design: Accounting for Uncertain Correlation and Volatility (August 17, 2015). Peregrine Securities, 2015. Available at SSRN: https://ssrn.com/abstract=2767437 or http://dx.doi.org/10.2139/ssrn.2767437

Anthony Seymour

University of Cape Town (UCT) ( email )

Private Bag X3
Rondebosch, Western Cape 7701
South Africa

Florence Chikurunhe

Peregrine Securities ( email )

21 Main Road
Claremont
Cape Town, Western Cape 7700
South Africa
+27117227551 (Phone)

HOME PAGE: http://www.peregrine.co.za

Emlyn James Flint (Contact Author)

Legae Peresec ( email )

15 Cavendish Street
Claremont
Cape Town, Western Cape 7700
South Africa
27117227556 (Phone)

HOME PAGE: http://www.legaeperesec.co.za

Department of Actuarial Science, University of Cape Town ( email )

Actuarial Science Section, University of Cape Town
Private Bag X3, Rondebosch
Cape Town, Western Cape 7701
South Africa
+27 21 650 2475 (Phone)

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