Optimal hedging of uncertain and long-term foreign exchange exposure |
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Authors: | Mark R Eaker Dwight Grant |
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Institution: | University of North Carolina, Chapel Hill, NC 27514, USA;North Carolina State University, Raleigh, NC 27695, USA |
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Abstract: | This paper employs stochastic dynamic programming to analyze two hedging problems which arise frequently, especially in international finance. One is the hedging of an uncertain exposure when the arrival of new information is anticipated. It is shown that a risk-averse agent will hedge a fraction of his maximum potential exposure to reduce risk. The second problem concerns hedging an exposure which extends beyond the delivery date of the available forward contract. The solution yields a rule by which successive contracts can be linked to form an optimal hedging strategy. A short empirical study illustrates this rule. |
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