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Daily Exchange Rate Behaviour and Hedging of Currency Risk

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Author Info
Charles S. Bos () (Erasmus University Rotterdam)
Ronald J. Mahieu (Rotterdam School of Management)
Herman K. van Dijk () (Econometric Institute, Erasmus University Rotterdam)

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Abstract

Exchange rates typically exhibit time-varying patterns in both means and variances. The histograms of such series indicate heavy tails. In this paper we construct models which enable a decision-maker to analyze the implications of such time series patterns 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 decision strategies. Consequently, we can make a distinction between statistical relevance of model specifications, and the economic consequences from a risk management point of view. The empirical results suggest that econometric modelling of heavy tails and time-varying means and variances pays off compared to a efficient markets model. The different ways to measure persistence and changing volatilities appear to strongly influence the hedging decision the investor faces.

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Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 99-078/4.

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Date of creation: 08 Oct 1999
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Handle: RePEc:dgr:uvatin:19990078

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Related research
Keywords: Bayesian decision making econometric modelling exchange rates risk management forward contracts stochastic volatility GARCH

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Find related papers by JEL classification:
C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Bayesian Analysis
C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Statistical Simulation Methods
C44 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Statistical Decision Theory; Operations Research
E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Charles S. Bos & Ronald J. Mahieu & Herman K. van Dijk, 2001. "On the Variation of Hedging Decisions in Daily Currency Risk Management," Tinbergen Institute Discussion Papers 01-018/4, Tinbergen Institute. [Downloadable!]
    Other versions:
  2. Siem Jan Koopman & Charles S. Bos, 2002. "Time Series Models with a Common Stochastic Variance for Analysing Economic Time Series," Tinbergen Institute Discussion Papers 02-113/4, Tinbergen Institute. [Downloadable!]
  3. Michel Beine & Charles S. Bos & Sebastian Laurent, 2005. "The Impact of Central Bank FX Interventions on Currency Components," Tinbergen Institute Discussion Papers 05-103/4, Tinbergen Institute. [Downloadable!]
    Other versions:
  4. L. Bauwens & C.S. Bos & H.K. Van Dijk & R.D. Van Oest, 2002. "Adaptive polar sampling, a class of flexibel and robust Monte Carlo integration methods," Econometric Institute Report 278, Erasmus University Rotterdam, Econometric Institute. [Downloadable!]
  5. Lennart Hoogerheide & Herman K. van Dijk, 2008. "Possibly Ill-behaved Posteriors in Econometric Models," Tinbergen Institute Discussion Papers 08-036/4, Tinbergen Institute, revised 18 Apr 2008. [Downloadable!]
  6. Charles S. Bos, 2008. "Model-based Estimation of High Frequency Jump Diffusions with Microstructure Noise and Stochastic Volatility," Tinbergen Institute Discussion Papers 08-011/4, Tinbergen Institute. [Downloadable!]
  7. Charles S. Bos & Neil Shephard, 2004. "Inference for Adaptive Time Series Models: Stochastic Volatility and Conditionally Gaussian State Space Form," Economics Papers 2004-W02, Economics Group, Nuffield College, University of Oxford. [Downloadable!]
    Other versions:
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