Currency Options and the Optimal Hedging of Contingent Foreign Exchange Exposure.

This paper applies an expected utility analysis to derive optimal contingent claims for hedging foreign exchange transaction exposures over the complete range of probabilities, as well the optimal forward and option hedge alternatives. Three utility functions are used, covering a wide range of risk postures. In marked contrast with the virtually universal endorsement of option hedging contingent exposures to be found in the financial management literature, the author's results indicate that options have little, if any, useful role to play in the hedging of transaction exposures of any sort. Copyright 1993 by The London School of Economics and Political Science.