Effectiveness of Developed and Emerging Market FX Options In Active Currency Risk Management

Active Currency Risk Management Using Option Structures: This paper explores the effectiveness of currency options in international portfolios. While most academic focus has been on assessing currency risk in a portfolio via measures such as VaR, CVaR etc, several practitioners aim to use this risk in their portfolio as a source of excess returns. We look at the role of FX option structures across developed markets in two contexts: a) as an complement to forwards for portfolio currency risks under the behavioral framework (BPT), and b) as a source of active risk management using MVS (mean variance skewness) and cross asset lower tail dependence framework. Previous research using CVAR as a risk mitigation metric shows forwards dominating options. However, measures using higher moments, such as maximising return and skew per portfolio risk may prove more useful. Furthermore, using this metric as a guide, portfolio currency exposures combined with market views can be incorporated into customized structures to generate uncorrelated excess returns.

Effectiveness of Emerging Market FX Options in Active Currency Risk Management: This paper explores the effectiveness of currency options in international portfolios. While most academic focus has been on assessing currency risk in a portfolio via measures such as VaR, CVaR etc, several practitioners aim to use this risk in their portfolio as a source of excess returns. We look at the role of FX option structures across emerging markets in two contexts: a) as an complement to forwards for portfolio currency risks under the behavioral framework (BPT), and b) as a source of active risk management using MVS (mean variance skewness) and cross asset lower tail dependence framework. Previous research using CVAR as a risk mitigation metric shows forwards dominating options. However, measures using higher moments, such as maximising return and skew per portfolio risk may prove more useful. Furthermore, using this metric as a guide, portfolio currency exposures combined with market views can be incorporated into customized structures to generate uncorrelated excess returns.