IDEAS home Printed from
   My bibliography  Save this paper

Is The FX Derivatives Market Effective and Efficient in Reducing Currency Risk?


  • Esteban Jadresic
  • Jorge Selaive


In a typical tactical asset allocation set up a manager receives compensation for his excess of return given a tracking error target. Critics of this framework cite its lack of control over the total portfolio risk. Current approaches recommend what we call a mixed allocation, derived from concerns about relative and absolute return and risk. This work provides an analytical framework for mixed tactical asset allocation, based on the premise that after the investor sets a tracking error target, a fundamental trade off remains unsolved: the one between excess of return and total risk. The article derives a separation theorem for tactical allocation, wherein the portfolio is a linear combination of an alpha portfolio providing excess returns and a beta portfolio providing overall risk hedge. The author shows how the formal expression summarizes all previous works. Moreover, it also includes the simplest Black-Litterman allocation.

Suggested Citation

  • Esteban Jadresic & Jorge Selaive, 2005. "Is The FX Derivatives Market Effective and Efficient in Reducing Currency Risk?," Working Papers Central Bank of Chile 325, Central Bank of Chile.
  • Handle: RePEc:chb:bcchwp:325

    Download full text from publisher

    File URL:
    Download Restriction: no

    References listed on IDEAS

    1. Martin D.D. Evans & Richard K. Lyons, 2017. "Order Flow and Exchange Rate Dynamics," World Scientific Book Chapters,in: Studies in Foreign Exchange Economics, chapter 6, pages 247-290 World Scientific Publishing Co. Pte. Ltd..
    2. Christopher J. Neely & Lucio Sarno, 2002. "How well do monetary fundamentals forecast exchange rates?," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 51-74.
    3. Bessembinder, Hendrik & Seguin, Paul J, 1992. " Futures-Trading Activity and Stock Price Volatility," Journal of Finance, American Finance Association, vol. 47(5), pages 2015-2034, December.
    4. Hau, Harald, 2002. "Real Exchange Rate Volatility and Economic Openness: Theory and Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(3), pages 611-630, August.
    5. Karpoff, Jonathan M., 1987. "The Relation between Price Changes and Trading Volume: A Survey," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(01), pages 109-126, March.
    6. Thomas Klitgaard & Laura Weir, 2004. "Exchange rate changes and net positions of speculators in the futures market," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 17-28.
    7. Kevin Cowan & Erwin Hansen & Luis Oscar Herrera, 2005. "Currency Mismatches, Balance-Sheet Effects and Hedging in Chilean Non-Financial Corporations," Research Department Publications 4387, Inter-American Development Bank, Research Department.
    8. Viviana Fernández, 2002. "The Derivatives Markets in Latin America with an Emphasis on Chile," Documentos de Trabajo 128, Centro de Economía Aplicada, Universidad de Chile.
    9. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-1335, November.
    10. Ross, Stephen A, 1989. " Information and Volatility: The No-Arbitrage Martingale Approach to Timing and Resolution Irrelevancy," Journal of Finance, American Finance Association, vol. 44(1), pages 1-17, March.
    11. Allayannis, George & Ofek, Eli, 2001. "Exchange rate exposure, hedging, and the use of foreign currency derivatives," Journal of International Money and Finance, Elsevier, vol. 20(2), pages 273-296, April.
    Full references (including those not matched with items on IDEAS)


    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.

    Cited by:

    1. Jose De Gregorio & Andrea Tokman R., 2004. "Overcoming Fear of Floating: Exchange Rate Policies in Chile," Working Papers Central Bank of Chile 302, Central Bank of Chile.
    2. Felipe Alarcón G. & Daniel Calvo C. & Pamela Jervis O., 2008. "Mercado de Cobertura Cambiaria y Tasa de Interés Local en Dólares," Notas de Investigación Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 11(2), pages 79-88, August.
    3. José De Gregorio R. / & Andrea Tokman R., 2005. "Fear of Floating and Exchange Rate Policy in Chile," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 8(3), pages 29-54, December.
    4. Patricio Jaramillo & Jorge Selaive, 2006. "Speculative Activity and Copper Price," Working Papers Central Bank of Chile 384, Central Bank of Chile.
    5. Roberto Alvarez & Erwin Hansen, 2017. "Corporate Currency Risk and Hedging in Chile: Real and Financial Effects," IDB Publications (Working Papers) 97976, Inter-American Development Bank.
    6. Jorge Selaive C., 2005. "Actividad del Mercado Cambiario y Movimiento del Tipo de Cambio Nominal," Notas de Investigación Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 8(3), pages 75-83, December.
    7. Dodd, Randall & Griffith-Jones, Stephany, 2007. "Report on derivatives markets: stabilizing or speculative impact on Chile and a comparison with Brazil," Documentos de Proyectos 134, Naciones Unidas Comisión Económica para América Latina y el Caribe (CEPAL).

    More about this item

    NEP fields

    This paper has been announced in the following NEP Reports:


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:chb:bcchwp:325. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Claudio Sepulveda). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.