Hedging currency risk across various market scenarios

economictimes.indiatimes.com:

However, in the modern era of Quant and AI, we have access to tools that can provide us with a comprehensive understanding and a more objective perspective. Having a model that encompasses all the significant variables and offers a relative assessment can be extremely beneficial. In order to counteract biases and make more well-informed decisions, we conceived the idea of developing a barometer that captures the underlying momentum in USD-INR.

This barometer aims to provide a means to gauge the direction and strength of the exchange rate (USD-INR), enabling more informed hedging strategies across various market cycles and multiple scenarios.There are numerous factors we have considered in our barometer, some of the most important being: — Dollar Index — FPI & FDI Flows — Trade Balance — Crude Prices — Real Effective Exchange Rates — U.S. Real Interest Rates — RBI Reaction Function All the variables incorporated in the model cover different factors which drive USD/INR. Care has been taken to avoid the problem of multicollinearity which is associated with multiple Regression models i.e.

where two or more independent variables are highly correlated. For instance, real rate differential drives FPI flows. Therefore, having both factors would result in multi-collinearity.

Crude prices predominantly drive inflation. Therefore, to have both crude and inflation in the model could potentially result in multicollinearity. Significant emphasis is placed on the dynamics of the Balance of Payments (BoP), with particular attention given to the influence of the Current Account, Capital Account, and Reserve Account (RBI reaction function) on the domestic currency.