Currency risks hedging for major and minor currencies: constant hedging versus speculative hedging

Abstract

Focusing on the recent experience of major and minor currencies, this study examines the effectiveness of constant hedge and speculative hedge respectively with the objective of identifying whether there are any significant differences between both hedges. Our finding is that the speculative hedge is very slightly more effective than the constant hedge in reducing the currency risk. This supports that the speculative hedge about major currencies can be a relevant hedging tool. The analysis also shows that our multiple currency futures hedge can be a good hedging instrument for some minor currencies such as Cyprus pound.

Notes

¹ A corporate hedger, for example, can adopt various internal instruments such as netting, matching, leading and lagging, price adjusting, assets and liabilities managing, currencies diversification, multiple currencies portfolio, etc. The net risk exposures are removed or reduced in a qualified corporate whose internal hedging opterations balance his long and short currency position. Whereas, the external instruments are traded in the markets so anyone is able to use them except a few trade barriers to some market participants. These are forward contracts, derivative contracts (currency futures, option and swap), lending and loaning in the money market, international factoring, insurance, and so on.

² In this article, the risk in the hedge is defined as the currency variation risk.

³ for more details, refer to Kahl (1983)'s formula and derivative in Witt et al. (1987)s paper, p. 137.

⁴  Source: Economic Research Economic Data (FRED) of Federal Reserve Bank of St. Louis, US.

⁵  Source: Website of barchart.com inc. (www.barchart.com).

⁶  Source: Website of Exchange-Rates Org. (www.exchange-rates.org).

⁷For instance, the null hypothesis of nonstationarity in D-F test is not rejected such as AUD = −3.18, Euro = −2.02, FAUD = −3.11, Feuro = −2.01, CYP = −1.84, FID = −1.96 and MAL = −1.93 under t = −3.43 at the 0.05 significant level for the t-test with drift and trend. The Augmented D-F test is excluded because the series is likely to be well represented by D-F test. Whereas the null hypothesis for the first differenced series is rejected such as AUD = −20.6, Euro = −21.4, FAUD = −20.4, FEuro = −20.9, CYP = −12.9, FID = −12.0 and MAL = −12.5.

⁸The null hypothesis of nonstationarity is rejected for AUD and Euro such as AUD = −12.64 and Euro = −12.71 under t = −3.37 at the 0.05 significant level for the t-test without drift and trend.