DP1083 | Short- and Long-term Hedging for the Corporation

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Publication Date

30/11/1994

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Abstract

Exchange risk hedging in a static (i.e. one-period) setting is extremely straightforward. The variance-minimizing hedge of a particular future cash flow involves a forward contract equal but opposite in sign to the exposure of the cash flow. The exposure is the regression coefficient of the cash flow on the exchange rate. In a multi-period setting, the matter is much less straightforward. Information concerning a future cash flow evolves over time. For that reason, a hedge undertaken early on may have to be revised several times. These revisions themselves increase the level of risk. In this paper I explore the case for deliberately leaving a cash flow unhedged for some time, initiating a hedge at some appropriate time and thereafter, perhaps, leaving the hedge untouched until the cash flow is received or paid. The precise mathematical theory in support of this idea has yet to be developed.