Hedging of Fixing Exposure

FX fixings are an indispensable and widely used reference rate in a market that trades continuously without an official close. Yet, a dealer's handling of fix transactions is a much debated topic. Especially when exposure to the fix is large relative to available market liquidity and hedging may extend to the pre-fix window, an inherent conflict of interest can arise between dealer and client. In this paper we use a model with permanent and transient market impact to characterize a dealer's optimal strategy to hedge fixing exposure. We show that smaller fix exposures are fully hedged over the calculation window, but that larger fix transactions are optimally hedged over a longer horizon that includes the pre-fix window. A client's all-in transaction costs can be lowered by pre-fix hedging provided that transient impact decays sufficiently quickly and dominates permanent impact.