Hedging of Fixing Exposure

39 Pages Posted: 24 Apr 2024 Last revised: 26 Apr 2024

See all articles by Johannes Muhle-Karbe

Johannes Muhle-Karbe

Imperial College London - Department of Mathematics

Roel C. A. Oomen

Deutsche Bank AG (London); Imperial College London - Department of Mathematics; London School of Economics & Political Science (LSE) - Department of Statistics

Benjamin Weber

Carnegie Mellon University

Date Written: April 16, 2024

Abstract

FX fixings are an indispensable and widely used reference rate in a market that trades continuously without an official close. Yet, a dealer's handling of fix transactions is a much debated topic. Especially when exposure to the fix is large relative to available market liquidity and hedging may extend to the pre-fix window, an inherent conflict of interest can arise between dealer and client. In this paper we use a model with permanent and transient market impact to characterise a dealer's optimal strategy to hedge fixing exposure. We show that smaller fix exposures are fully hedged over the calculation window, but that larger fix transactions are optimally hedged over a longer horizon that includes the pre-fix window. A client's all-in transaction costs can be lowered by pre-fix hedging when transient impact decays sufficiently quickly and dominates permanent impact.

Suggested Citation

Muhle-Karbe, Johannes and Oomen, Roel C.A. and Weber, Benjamin, Hedging of Fixing Exposure (April 16, 2024). Available at SSRN: https://ssrn.com/abstract=4796356 or http://dx.doi.org/10.2139/ssrn.4796356

Johannes Muhle-Karbe

Imperial College London - Department of Mathematics ( email )

South Kensington Campus
Imperial College
LONDON, SW7 1NE
United Kingdom

HOME PAGE: http://www.ma.imperial.ac.uk/~jmuhleka/

Roel C.A. Oomen (Contact Author)

Deutsche Bank AG (London) ( email )

Winchester House
1 Great Winchester Street
London, EC2N 2DB
United Kingdom

Imperial College London - Department of Mathematics ( email )

South Kensington Campus
Imperial College
LONDON, SW7 2AZ
United Kingdom

London School of Economics & Political Science (LSE) - Department of Statistics ( email )

Houghton Street
London, England WC2A 2AE
United Kingdom

Benjamin Weber

Carnegie Mellon University ( email )

Pittsburgh, PA 15213-3890
United States

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