Cross-hedging with futures and options : bivariate lognormal and other distributions
Biagioli, Anthony J. F.
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Chang and Wong investigated the optimal hedging strategy for a multinational firm which has future cash flows in a foreign currency but is unable to directly hedge the exchange rate risk. The firm then uses a third currency to partially hedge the risk. This paper generalizes the paper of Chang and Wong by showing that some of the assumptions about the distributions of the stochastic process generating the exchange rates are more restrictive than necessary, i.e., that the same results hold under weaker assumptions. It then does specific calculations for the case of bivariate lognormal distributions and compares the results to those of Chang and Wong. Using the bivariate lognormal model with a term for inflation gives the best performance under a real-life data set.