Price uncertainty, future markets and correlation

Harald Battermann and Udo Broll ()

International Economic Journal, 2004, vol. 18, issue 2, 237-243

Abstract: This paper examines the optimal trade and hedging decisions of a competitive exporting firm which faces concurrently hedgeable exchange rate risk and non-hedgeable inflation risk. The macroeconomic interaction between exchange rate and domestic inflation rate risk is described by a state variable. The (strong) correlation is pivotal in determining the optimal risk management. It is shown how optimal hedging strategies are affected by state-dependent preferences of the firm. The optimal hedge policy is to minimize the variation of marginal utility of final wealth across states of nature instead of minimizing the variance of final wealth.

Keywords: Exchange rate risk; inflation risk; state-dependent preferences; hedging; strong correlation (search for similar items in EconPapers)
Date: 2004
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DOI: 10.1080/1016873042000228358

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