Key question
Which hedging instrument and maturity structure minimise the cost of carry while still protecting against EM currency depreciation?
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Two hedging approaches are compared. The first is a special case of the second, shown separately for clarity: 100% of exposure is hedged at a single fixed maturity. The second is more flexible: the hedge ratio and maturity structure can be distributed across multiple tenors.
Average cost of hedging strategy
The forward eliminates volatility entirely but systematically overpays: average annual carry 6.54%. Hedge efficiency 15.3 — the price of absolute predictability.
Realised carry
6.54%
average over 2000–2018
One-sided vol reduction
100%
vs spot (14.35%) · hedge eff: 15.3
Hedging instrument comparison
Bottom-left is ideal: minimum carry at minimum vol. The forward eliminates vol entirely but is expensive in carry terms. The ATMF option has historically been closest to the optimum.
EM currency comparison · optimal instrument
The optimal instrument depends on the currency's carry level. At moderate carry (3–8%), the ATMF option has historically offered the best protection-to-cost ratio. At very high carry (TRY), a forward is the only viable option — option premiums are too high. At low carry (PLN), OTMF is cheaper.
Brazil
Mexico
South Africa
India
Poland
Turkey
Hedge efficiency = one-sided vol reduction / realised carry. USDBRL 2000–2018 data is exact (Ch. 19). Others are estimates based on historical currency characteristics. ↑ ATMF is the best instrument at moderate carry; forward at extreme carry.
Maturity comparison · USDBRL · best instrument
The optimal instrument depends on the hedging horizon. At short maturities the carry difference is small — ATMF is cheap. At longer maturities, forward carry accumulates, strengthening the advantage of ATMF.
| Maturity | Forward carry · vol | ATMF carry · vol | OTMF carry · vol | Risk Reversal carry · vol | Best |
|---|---|---|---|---|---|
| 3M | 1.64% · 0% | 0.27% · 10.9% | 0.23% · 13.3% | 1.54% · 8.9% | ATMF |
| 6M | 3.27% · 0% | 0.54% · 10.2% | 0.47% · 12.3% | 3.08% · 8.9% | ATMF |
| 9M | 4.91% · 0% | 0.81% · 7.5% | 0.70% · 11.3% | 4.61% · 8.9% | ATMF |
| 12M | 6.54% · 0% | 1.08% · 5.2% | 0.93% · 10.3% | 6.15% · 8.9% | ATMF |
| Stagger (4M+8M+12M) | 4.3% · 9.9% | ≈0.6% · 9.9% | ≈0.5% · — | ≈4.0% · — | Stagger V |
carry · one-sided vol · USDBRL. 12M — exact data from Table 19.4. 3M/6M/9M — estimates based on scaling by period. Forward: vol reduced to 0% via full hedging.
Demo is based on historical data. In the full version — current data, your currency, your company's portfolio.