Can somebody explain the difference? thnx
proxy - use a currency that is highly correlated with the home currency you want hedging for.
Cross hedge - use 2 currencies other than the home currency for hedging.
Suppose you have 4 currencies
$ - your domestic currency
NKr -krone currency - you have bought this currency bond
Skr - swedish krona - negatively correlated to NKr
Euro - +vely correlated with NKr
So proxy hedge - enter into euro to exchange for dollar at year end
Cross hedge - enter to buy SKr by selling Nkr - then Sell Skr & Buy $
Cross hedge -> you have NKr bond - need to hedge its movements against USD.
I would think you would be better served going Nkr/Euro and Euro/USD
If you used SKr which is negatively correlated with Nkr - you might not have the best results.
yes , you do not do the Skr USD portion at all in the cross hedge case
You trust that the USD-NKr relationship is about same as the SKr-Euro relationship.
So go long SKr while selling Euro . This would approximate the desired USD-NKr hedge
The availability of forward contracts, the correlation between currencies, and the expectation of the currency exchange rate could make the question more involved…Cross hedge just transfers the currency risk from one to another, so it’s not a “complete” hedge.
Proxy,… domestic is hedged with different foreign currency
Cross: to different foreign currency used to hedge the exposure