Treasury management model with foreign exchange exposure

Konstantin Volosov; Gautam Mitra; Fabio Spagnolo; Cormac Lucas

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SPEPS Preprint

Author(s):	Konstantin Volosov, CARISMA : The Centre for the Analysis of Risk and Optimisation Modelling Application, Brunel University Gautam Mitra, CARISMA : The Centre for the Analysis of Risk and Optimisation Modelling Application, Brunel University Fabio Spagnolo, CARISMA : The Centre for the Analysis of Risk and Optimisation Modelling Application, Brunel University Cormac Lucas, CARISMA : The Centre for the Analysis of Risk and Optimisation Modelling Application, Brunel University
Title:	Treasury management model with foreign exchange exposure
Date of Acceptance:	15.06.2004
Submission Date:	11.05.2004
Series Title:	Stochastic Programming E-Print Series (SPEPS)
Editors:	Julie L. Higle; Werner Römisch; Surrajeet Sen
Complete Preprint:	pdf (urn:nbn:de:kobv:11-10059599) ps (urn:nbn:de:kobv:11-10059605)
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Abstract (eng):

In this paper we formulate a model for foreign exchange exposure management and (international) cash management taking into consideration random fluctuations of exchange rates. A vector error correction model (VECM) is used to predict the random behaviour of the forward as well as spot rates connecting dollar and sterling. A twostage stochastic programming (TWOSP) decision model is formulated using these random parameter values. This model computes currency hedging strategies, which provide rolling decisions of how much forward contracts should be bought and how much should be liquidated. The model decisions are investigated through ex post simulation and backtesting in which value at risk (VaR) for alternative decisions are computed. The investigation (a) shows that there is a considerable improvement to "spot only" strategy, (b) provides insight into how these decisions are made and (c) also validates the performance of this model.

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