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Corporate Hedging: an answer to the "how" question
Linköping University, Department of Electrical Engineering. Linköping University, Department of Management and Engineering, Production Economics. Linköping University, Faculty of Science & Engineering.
Linköping University, Department of Management and Engineering, Production Economics. Linköping University, Faculty of Science & Engineering.ORCID iD: 0000-0002-4858-1479
(English)In: Annals of Operations Research, ISSN 0254-5330, E-ISSN 1572-9338Article in journal (Refereed) Accepted
Abstract [en]

We develop a stochastic programming framework for hedging currency and interest rate risk, with market traded currency forward contracts and interest rate swaps, in an environment with uncertain cash flows. The framework captures the skewness and kurtosis in exchange rates, transaction costs, the systematic risks in interest rates, and most importantly, the term premia which determine the expected cost of different hedging instruments. Given three commonly used objective functions: variance, expected shortfall, and mean log profits, we study properties of the optimal hedge. We find that the choice of objective function can have a substantial effect on the resulting hedge in terms of the portfolio composition, the resulting risk and the hedging cost. Further, we find that unless the objective is indifferent to hedging costs, term premia in the different markets, along with transaction costs, are fundamental determinants of the optimal hedge. Our results also show that to reduce risk properly and to keep hedging costs low, a rich-enough universe of hedging instruments is critical. Through out-of-sample testing we validate the findings of the in-sample analysis, and importantly, we show that the model is robust enough to be used on real market data. The proposed framework offers great flexibility regarding the distributional assumptions of the underlying risk factors and the types of hedging instruments which can be included in the optimization model.

Place, publisher, year, edition, pages
New York, United States: Springer-Verlag New York.
Keyword [en]
Stochastic programming, Currency hedging, Term premia, Uncertain cash flows, Risk management
National Category
Economics
Identifiers
URN: urn:nbn:se:liu:diva-142117DOI: 10.1007/s10479-017-2645-6OAI: oai:DiVA.org:liu-142117DiVA, id: diva2:1151261
Available from: 2017-10-23 Created: 2017-10-23 Last updated: 2017-10-31Bibliographically approved

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Blomvall, JörgenEkblom, Jonas

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  • apa
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