Abstract
This dissertation consists of three essays. The first essay concerns hedging currency risk using futures. In this essay, the various techniques of hedging currency risk using futures are compared and recommendations are made. In addition, a new technique of hedging currency risk with futures is proposed. In this approach, the hedge ratio is determined by taking the first derivative of the futures equation. In the second essay, three different techniques of pricing currency call and put options are analyzed. Two of these three methods treat interest rates as stochastic and one as constant. The three methods are evaluated with both historical and implied volatilities. The third essay illustrates condition under which it is optimal to use futures over options and vice-versa as a hedging tool. This analysis is carried out under symmetric as well as asymmetric information. Preferences are determined by stochastic dominance procedures. In cases where stochastic dominance is not found, expected utility criteria is used for risk averse investors.
The major findings are that when futures are used as a hedging tool, the technique proposed in this paper gives the best way to hedge for short duration. This is not true for longer duration hedges where other methods provide better results. Regression-based hedging techniques with futures have two problems inherent in them. One is the information inefficiency problem and other is the spot-future price convergence problem. It is found that the hedging technique that accounts for both these problems provides with the best results for longer duration hedges. Options are priced better if stochastic interest rates are used. Also, use of implied volatility leads to better results than historical volatility. Under asymmetric information, different circumstances lead to different result. All the different possible circumstances are analyzed and recommendations are made.