Currency risk hedging: Futures vs. forward

The objective of this paper is to address the issue of choosing between currency forward and currency futures contracts when hedging against currency risk within a stochastic interest rates environment. We compare between the hedging effectiveness of the two derivative assets both within a narrow sense (i.e., volatility minimization) and within a wide sense (i.e., risk-return trade-off). When judging hedging effectiveness in the narrow sense, forward and futures contracts give identical results even if they do not have identical prices. When judging hedging effectiveness in the wide sense, the choice between the two contracts is determined by the correlation between the domestic and the foreign term structures dynamics.