THE TERM STRUCTURE OF CURRENCY HEDGE RATIOS

Olaf Korn () and Philipp Koziol
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Olaf Korn: Georg-August-Universität Göttingen and Centre for Financial Research Cologne (CFR), Platz der Göttinger Sieben 3, D-37073 Göttingen, Germany

International Journal of Theoretical and Applied Finance (IJTAF), 2011, vol. 14, issue 04, 525-557

Abstract: This paper investigates the variance minimizing currency forward hedge of an exporting firm that is exposed to different sources of risk. In an empirical study, we quantify the corresponding hedge ratios of a "typical" German firm for different hedge horizons. Based on cointegrated vector autoregressive models of prices, interest rates and exchange rates, we show that hedge ratios decrease substantially with the hedge horizon for different currencies, reaching values of one half or less for a ten-years horizon. Our findings can partly explain underhedging of long-term exchange rate exposures and have important implications for the design of risk management strategies.

Keywords: Corporate risk management; foreign exchange risk; hedging; cointegrated VAR model (search for similar items in EconPapers)
Date: 2011
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DOI: 10.1142/S0219024911006723

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