Cross Hedge

I am trying to understand the concept of cross hedge. Is it simply hedging by using other unrelated instruments? For instance, buying gold and selling silver.

Trying to undertsand the concept. Thanks.

Not unrelated instruments, they are using instruments which have similar price movements. Basically done to limit the upside and the downside.

ok… what is the difference between that an a normal hedge then?

Cross here refers to the point that, you are using a related instrument and not the same instrument (or a derivative of the instrument) in itself.

Suppose that your home currency is the BRL (Brazilian real) and you have a large payment coming in THB (Thai bhat). You’d like to hedge the exchange rate risk, but there are no BRL/THB forward contracts available. However, there is a strong, positive correlation between the price of THB and the price of CNY (Chinese yuan), and there are BRL/CNY forwards available, so you hedge using one of those forwards.

That’s a cross hedge.

What i find more subtle is the difference between Proxy Hedge and Cross Hedge. i think i have seen one or two past mocks on this.

The current reading doesn’t distinguish between a cross hedge and a proxy hedge.

In the example I gave, some authors would call hedging with BRL/CNY forwards a proxy hedge and hedging with THB/CNY forwards a cross hedge.

At the moment, you needn’t worry about the (terminological) difference.

Perfect answer magician! thanks.

My pleasure.

I was searching for this term ‘positive correlation’ while asnwering (instead used the term related instrument)! You magician sir are awesome! (thats between business as usual for magician though :))…

You’re too kind.

I am not using the latest study material but the one of 2014 (maybe i shouldn’t) and the definitions of cross hedging and proxy hedging are both mentioned (below in my own words, sorry for my imperfect English): If we are exposed to currency A and would like to hedge this exposure: Using a forward contract between the home currency and a currency that is highly positively correlated with currency A is called proxy hedging. Using a forward contract between currency A and another currency, not involving the home currency, but that is expected to convert the existing currency risk into a less risky exposure, is called cross hedging. Put differently: Regular Hedging involves the home currency and currency A. Proxy hedging involves the home currency but not currency A. Cross hedging involves currency A but not the home currency (to be more precise i think you can also cross hedge using neither the home currency nor currency A). Please let me know if anyone has a different understanding.

That agrees with what I wrote above. However, as I also wrote, the current reading doesn’t make a distinction between a cross hedge and a proxy hedge.

Thanks a lot :slight_smile:


If I own BRL (Brazilian real), i buy a ATM put to protect the BRL downside risk. Does it belongs to cross hedge or direct hedge? Thanks.

Depends on the currency pair you were buying.

If you bought something with BRL as a part of the pair - it is a direct hedge.

If you thought e.g. that the MXN (Mexican peso) was a currency that closely resembled the BRL (MXN highly correlated to BRL), and decided to use MXN as part of your currency pair - it would be a Cross hedge.

Thanks, that’s my understanding as well. But when i read kaplan, it seems if ussing different asset class to hedge, it also belongs to cross hedge? Thanks.

Kaplan B.1 p.344

Purchasing puts on the concentrated position is also considered a cross-hedge in that the put and stock are different types of assets.

Not quite (at least, according to the CFA Institute curriculum). It’s a cross hedge if you use a hedging instrument that has a strong positive price correlation with your concentrated position, which is consistent with the treatment we’ve been discussing with currencies.

Suppose that you have a concentrated position in stock of a large-cap company. If you buy puts on that company’s stock, it’s a direct hedge. If you buy S&P 500 puts, it’s a cross hedge.

Thanks Magician, cpk.