Currency Correlation Hedge Calculator
Calculate how much of a correlated currency position you need to hold to offset the risk of your primary currency exposure. Use it when structuring a cross-currency hedge where a perfect direct hedge is unavailable or too costly.
About this calculator
When a direct hedge for a currency exposure is not available or is prohibitively expensive, traders use a correlated currency as a proxy hedge. The optimal hedge amount is determined by the ratio of the two currencies' volatilities scaled by their correlation: hedgeAmount = primaryExposure × correlation × (primaryVolatility / hedgeCurrencyVol) × (1 − hedgingCost/100). The term correlation × (primaryVolatility / hedgeCurrencyVol) is the minimum-variance hedge ratio, derived from linear regression of returns of the primary currency against the hedge currency. A correlation of 1.0 with equal volatilities gives a 1:1 hedge. Lower correlation or a larger volatility mismatch reduces the optimal hedge size. The hedging cost factor then adjusts downward to reflect the real-world cost of maintaining the position.
How to use
Primary USD exposure: $500,000. Primary currency volatility: 14%. Hedge currency volatility: 10%. Correlation: 0.75. Hedging cost: 0.5%. Step 1: volatility ratio = 14/10 = 1.4. Step 2: hedge ratio = 0.75 × 1.4 = 1.05. Step 3: apply hedging cost: 1.05 × (1 − 0.005) = 1.05 × 0.995 = 1.04475. Step 4: hedge amount = $500,000 × 1.04475 = $522,375. You should take a $522,375 position in the hedge currency to minimize portfolio variance.
Frequently asked questions
What is a minimum-variance hedge ratio and why does it depend on correlation?
The minimum-variance hedge ratio is the position size in a hedge instrument that minimizes the variance of a combined portfolio of the original exposure and the hedge. It equals the correlation between the two assets multiplied by the ratio of their volatilities. If correlation is low, the hedge is less effective and the optimal ratio is smaller. If the hedge currency is more volatile than the primary currency, you need a smaller position in it to achieve the same risk offset, and vice versa.
When is a cross-currency proxy hedge better than a direct hedge?
A direct hedge — such as selling the exact currency you are exposed to in the forward market — is always theoretically superior, but it may not always be practical. Some currencies lack liquid forward markets, or the bid-ask spread and overnight financing costs make a direct hedge prohibitively expensive. In these cases, a highly correlated liquid currency (such as using the AUD to proxy-hedge NZD exposure) can provide meaningful risk reduction at a fraction of the cost, even if it is not a perfect hedge.
How does hedging cost affect the optimal currency hedge position size?
Hedging costs — which include the bid-ask spread on forward contracts, swap points, and broker commissions — reduce the net benefit of the hedge and therefore justify a slightly smaller position. This calculator applies the cost as a proportional reduction to the gross hedge ratio. In practice, if hedging costs are very high (above 1–2% per year), the cost of the hedge may exceed the expected benefit from risk reduction, and a partial or unhedged position might be more economical.