An increasing number of asset managers are turning to fx as a cheaper, more liquid way to hedge cross-asset portfolios. They are prepared to accept some mismatch between the risk profile of their portfolio and their fx hedge, but are ultimately looking for hedging instruments which provide a payoff in times of risk aversion. The term risk aversion can be measured, and therefore traded, in one of the following three ways: carry unwind, increase in correlation and an increase in fx volatility.
Carry Unwind
The most basic way to hedge risk aversion would be to enter into long dated forward sales of high yielding currencies, but this implies paying the carry. Historically, this strategy would have resulted in infrequent, but large gains at the expense of frequent, but small losses.
Alternatively, portfolio managers purchase put options on high yielding currencies as catastrophe cover against extreme market moves. This can ....