The cross-currency hedging performance of implied versus statistical forecasting models

This paper examines the ability of several models to generate optimal hedge ratios. Statistical models employed include univariate and multivariate GARCH models, and exponentially weighted and simple moving averages. The variances of the hedged portfolios derived using these hedge ratios are compared with those based on market expectations implied by the prices of traded options. One-month and three-month hedging horizons are considered for four currency pairs. Overall, we find that an exponentially weighted moving average model leads to lower portfolio variances than any of the GARCH-based, implied or time-invariant approaches.