Behavioral Pattern of Emerging Asia Currency
Option Risk Reversals: An Indicator
for Foreign Exchange Hedging

Abstract

By identifying Emerging Asia currency option risk reversal as a behavioral variable, we find the influence of currency spot return and carry return has significant bearing in hedging patterns of foreign exchange market participants. We note that appreciation of Emerging Asia currencies in the foreign exchange spot market as well as increased carry return tend to mislead foreign exchange market participants from fully hedging their trading exposure in Emerging Asia currencies, which were notable in all 10 currencies that were analyzed, with the exception of the Chinese yuan. In the case of the Chinese yuan, foreign exchange market participants were fully hedged against changes in the currency spot return and carry return. In this study, the influence of hedging patterns was identified by using the outlying factor as a barometer in modelling hedging patterns of foreign exchange market participants, as well the correlation among currency option risk reversals, currency spot return, and carry return.