Optimal Hedging of the Currency Exchange Risk Exposure of Dynamically Balanced Strategic Asset Allocations

29 Pages Posted: 4 Mar 2002

See all articles by Nikolaus Hautsch

Nikolaus Hautsch

University of Vienna - Department of Statistics and Operations Research; Center for Financial Studies (CFS); Vienna Graduate School of Finance (VGSF)

Joachim Inkmann

University of Melbourne - Department of Finance; Financial Research Network (FIRN)

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Abstract

This paper presents theoretical and empirical results on the magnitude of optimal hedge ratios for a dynamically balanced strategic asset allocation with multiple currencies. Optimality refers to a mean-variance objective function with a time-varying risk-aversion parameter. A data driven choice of this parameter is proposed, which is suggested by a Sharpe ratio maximization criterion and renders the vector of optimal hedge ratios scale invariant. Empirical results are given for an EMU based investor with USD, GBP and JPY assets and an US based investor with assets in EUR, GBP and JPY. Since the vector of optimal hedge ratios depends on the conditional variance-covariance matrix of the involved exchange rate return time series, multivariate GARCH models are estimated. In particular, ML estimation of the DCC-GARCH model is performed, which remains computationally attractive in large dimensional cases. A fixed-mix rebalancing investment rule is applied in order to maintain the strategic asset allocation over time. Finally, hedging strategies for subsidiary companies are investigated, which account for the hedging interests of their mother company.

Keywords: Currency overlay management, optimal hedging, DCC-GARCH

Keywords: Currency overlay management, optimal hedging, rebalancing, fixed-mix, DCC-GARCH

JEL Classification: C32, G15

Suggested Citation

Hautsch, Nikolaus and Inkmann, Joachim, Optimal Hedging of the Currency Exchange Risk Exposure of Dynamically Balanced Strategic Asset Allocations. Journal of Asset Management, Vol. 4, No. 3, pp. 173-189, Forthcoming. Available at SSRN: https://ssrn.com/abstract=302152 or http://dx.doi.org/10.2139/ssrn.302152

Nikolaus Hautsch (Contact Author)

University of Vienna - Department of Statistics and Operations Research ( email )

Oskar-Morgenstern-Platz 1
Vienna, A-1090
Austria

Center for Financial Studies (CFS) ( email )

Gr├╝neburgplatz 1
Frankfurt am Main, 60323
Germany

Vienna Graduate School of Finance (VGSF) ( email )

Welthandelsplatz 1
Vienna, 1020
Austria

Joachim Inkmann

University of Melbourne - Department of Finance ( email )

Level 12, 198 Berkeley Street
University of Melbourne, Victoria 3010
Australia
0061 3 9035 8177 (Phone)

HOME PAGE: http://orcid.org/0000-0002-5526-7648

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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