Currency hedging for a multi-national firm

Markku Kallio*, Matti Koivu, Rudan Wang

*Corresponding author for this work

Research output: Chapter in Book/Report/Conference proceedingChapterScientificpeer-review

Abstract

This paper develops a multi-stage stochastic programming (SP) approach aiding a European company in currency hedging. While cash management concerns several major currencies, our pilot model deals with US$ and € only. Equilibrium correction models, Taylor rule based models and a random walk model are compared for exchange rate prediction. Risks related to exchange rate and sales forecast errors are hedged. Numerical results indicate that the current hedging policy roughly amounts to the same as no hedging at all. We demonstrate how repeated hedging activity reduces risk and thereby suggests avoid excessive risk averse behavior. Out-of-sample tests over the period 2004–2013 indicate that optimized hedging can increase net profits before taxes by about 20% over current policy. Average performance improvement of the random walk model is outperformed in terms of profit improvement by all other models we considered. Out-of-sample results show that single-stage SP yields approximately the same average improvement as multi-stage SP but the latter is more robust in terms of reduced variance.

Original languageEnglish
Title of host publicationHandbook of Recent Advances in Commodity and Financial Modeling
Pages297-320
Number of pages24
Volume257
ISBN (Electronic)978-3-319-61320-8
DOIs
Publication statusPublished - 2018
MoE publication typeA3 Part of a book or another research book

Publication series

NameInternational Series in Operations Research and Management Science
Volume257
ISSN (Print)0884-8289

Keywords

  • Currency hedging
  • Exchange rate
  • Financial modeling
  • Stochastic programming

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