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Treasury Management Model with Foreign Exchange Exposure

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Abstract

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 two-stage 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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Authors and Affiliations

  1. CARISMA: The Centre for the Analysis of Risk and Optimisation Modelling Applications, Brunel University, Uxbridge, Middlesex, UB8 3PH, UK

    Konstantin Volosov, Gautam Mitra, Fabio Spagnolo & Cormac Lucas

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  1. Konstantin Volosov
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  2. Gautam Mitra
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  3. Fabio Spagnolo
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  4. Cormac Lucas
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Volosov, K., Mitra, G., Spagnolo, F. et al. Treasury Management Model with Foreign Exchange Exposure. Comput Optim Applic 32, 179–207 (2005). https://doi.org/10.1007/s10589-005-2059-2

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