A Stochastic Dominance Approach to Evaluating Foreign Exchange Hedging Strategies

We offer a new approach to evaluating foreign exchange hedging strategies. The approach is practical since it is couched in terms of business variables such as profits, rates of return, and revenues. It is also consistent with utility-maximizing behavior since it is based on standard stochastic domi...

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Bibliographic Details
Published in:Financial management 1992-10, Vol.21 (3), p.104-112
Main Authors: Hunter, William C., Timme, Stephen G.
Format: Article
Language:English
Subjects:
Business risks
Currency transactions
Efficient strategies
Exporters
Financial portfolios
Forecasting models
Foreign exchange
Foreign exchange rate risk
Foreign exchange rates
Foreign subsidiaries
Hedging
International financial management
Multinational corporations
Probability distribution
Risk aversion
Statistical analysis
Stochastic analysis
Stochastic models
Time series forecasting
Utility functions
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Summary:We offer a new approach to evaluating foreign exchange hedging strategies. The approach is practical since it is couched in terms of business variables such as profits, rates of return, and revenues. It is also consistent with utility-maximizing behavior since it is based on standard stochastic dominance rules. By taking account of all points of the hedging strategies' outcome distributions, the approach avoids the problems associated with popular selection procedures such as the mean-variance criterion. These problems can occur, for example, when the hedging outcome distributions are nonnormal. A stylized example for hedging transaction exposure is presented to demonstrate how the stochastic dominance evaluation methodology is easily implemented, that it is theoretically sound, and not restrictive in terms of its underlying assumptions.
ISSN:0046-3892
1755-053X
DOI:10.2307/3666023