Daily exchange rate behaviour and hedging of currency risk

We construct models which enable a decision maker to analyse the implicatio ns of typical time series patterns of daily exchange rates for currency ris k management. Our approach is Bayesian where extensive use is made of Marko v chain Monte Carlo methods. The effects of several model characteristics ( unit roots, GARCH? stochastic volatility, heavy-tailed disturbance densitie s) are investigated in relation to the hedging strategies. Consequently, we can make a distinction between statistical relevance of model specificatio ns and the economic consequences from a risk management point of view. We c ompute payoffs and utilities from several alternative hedge strategies. The results indicate that modelling time-varying features of exchange rate ret urns may lead to improved hedge behaviour within currency overlay managemen t. Copyright (C) 2000 John Wiley & Sons, Ltd.