Cross-Hedging with Currency Options and Futures

30 Pages Posted: 28 Feb 2003

See all articles by Eric C. Chang

Eric C. Chang

University of Hong Kong - School of Business

Kit Pong Wong

University of Hong Kong

Multiple version iconThere are 2 versions of this paper

Date Written: April 2002

Abstract

This paper develops an expected utility model of a multinational firm facing exchange rate risk exposure to a foreign currency cash flow. Currency derivative markets do not exist between the domestic and foreign currencies. There are, however, currency futures and options markets between the domestic currency and a third currency to which the firm has access. Since a triangular parity condition holds among these three currencies, the available, yet incomplete, currency futures and options markets still provide a useful avenue for the firm to indirectly hedge against its foreign exchange risk exposure. This paper offers analytical insights into the optimal cross-hedging strategies of the firm. In particular, the results show the optimality of using options in conjunction with futures in the case of currency mismatching, even though cash flows appear to be linear.

Suggested Citation

Chang, Eric Chieh C. and Wong, Keith Kit Pong, Cross-Hedging with Currency Options and Futures (April 2002). Available at SSRN: https://ssrn.com/abstract=307842 or http://dx.doi.org/10.2139/ssrn.307842

Eric Chieh C. Chang (Contact Author)

University of Hong Kong - School of Business ( email )

Meng Wah Complex
Pokfulam Road
Hong Kong
China

Keith Kit Pong Wong

University of Hong Kong ( email )

Faculty of Business and Economics
University of Hong Kong
Hong Kong, Nil Nil
Hong Kong
(852) 2859-1044 (Phone)
(852) 2548-1152 (Fax)

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