Forwards versus Options: Effectiveness in Hedging Currency Risk in International Portfolios

Abstract: This paper aims to examine effectiveness of currency hedging of forward contracts and options in international portfolio, consisting of assets denominated in Chinese Yuan and Indian Rupee. Instead of applying Markowitz’s portfolio optimization, mean-CVaR framework is used in order to deal with non-normality of return of financial assets as well as exchange rates. In this paper, the finding shows that hedging strategies, either with forwards or options yield better performance compared to unhedged strategy. In this research, there is no clear conclusion whether forward contracts or put options outperforms one another. The conclusion is different at different level of strike prices. Forward contract is more effective compared to put option with strike price of 1%, 5% and 10% above spot rate whereas put option with strike price of 15% above spot rate is more effective compared to forwards in term of hedging currency risk in international portfolio.