Exchange Rate Economic Exposure under Collusive Pricing and Hedging using Asian Options

This paper provides a financial engineering exercise for a specific form of exchange rate economic (competitiveness) exposure and discusses the hedging solution for this exposure. Specifically, it analyses exposure in a market where international competitors follow a type of collusive pricing behaviour, and derives the risk profile of this exposure. It then proposes a hedging scenario based on a portfolio of Asian Currency Options consisting of a 1:1 Bull Cali Spread and a short put. The practical implications of this paper are of interest to currency option traders who can launch new hedging applications of currency option portfolios, and to exposed firms facing this particular form of economic exposure.