Daily Exchange Rate Behaviour and Hedging of Currency Risk
Charles S. Bos 1
Econometric and Tinbergen Institutes,
Erasmus University Rotterdam
Ronald J. Mahieu
Rotterdam School of Management,
Erasmus University Rotterdam
Herman K. van Dijk
Econometric and Tinbergen Institutes,
Erasmus University Rotterdam
August 20, 1999
August 31, 2000, revised
Abstract
We construct models which enable a decision-maker to analyze the
implications of typical time series patterns of daily exchange rates
for currency risk management.
Our approach is Bayesian where extensive use is made of Markov chain
Monte Carlo methods. The effects of several model characteristics (unit
roots, GARCH, stochastic volatility, heavy tailed disturbance densities)
are investigated in relation to the hedging strategies.
Consequently, we can make a distinction between statistical relevance of
model specifications, and the economic consequences from a risk
management point of view. We compute payoffs and utilities from several alternative
hedge strategies. The results indicate that modelling time varying
features of exchange rate returns may lead to improved hedge behaviour
within currency overlay management.
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JEL classification: | C11, C44, E47, G15 |
| Keywords: |
Bayesian decision making, econometric modelling,
exchange rates, risk management, stochastic volatility, GARCH
|
Footnotes:
1 Correspondence to Charles Bos,
Econometric Institute, Erasmus University Rotterdam,
PO Box 1738, NL-3000 DR Rotterdam, The Netherlands.
Email: cbos@feweb.vu.nl,
URL: http://www.tinbergen.nl/cbos/.
We thank three anonymous referees, the co-editor, Rob Engle, Christopher
Gilbert, Frank de Jong, Michel Lubrano, Allan Timmermann and participants of seminars
at UC-San Diego, UCLA, UC-Irvine, EC2 in Madrid, ISBA-2000, and at
universities in Stockholm, Marseilles and Amsterdam for several remarks which
led to substantial improvements on earlier versions of this paper.
The authors retain full responsibility for remaining errors.
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