HEDGING AND THE COMPETITIVE FIRM UNDER AMBIGUOUS PRICE AND BACKGROUND RISK

This paper examines the optimal production and hedging decisions of the competitive firm that possesses smooth ambiguity preferences and faces ambiguous price and background risk. The separation theorem holds in that the firm's optimal output level depends neither on the firm's attitude towards ambiguity nor on the incident to the underlying ambiguity. We derive necessary and sufficient conditions under which the full‐hedging theorem holds and thus options are not used. When these conditions are violated, we show that the firm optimally uses options for hedging purposes if ambiguity is introduced to the price and background risk by means of mean‐preserving spreads. We as such show that options play a role as a hedging instrument over and above that of futures.     

Export Flexibility And Currency Hedging*

This article studies the behavior of an export‐flexible firm under exchange rate uncertainty. We show that the separation theorem holds if selling exclusively in the domestic market is suboptimal even under the most unfavorable spot exchange rate. Otherwise, the firm's optimal output depends on its preferences and on the underlying uncertainty. We further show that the full‐hedging theorem holds only when the firm always finds it optimal to sell its entire output in the foreign market. Otherwise, export flexibility introduces a convexity into the firm's foreign exchange risk exposure, which calls for the use of currency options for hedging purposes.     

OPTIMAL EXPORT AND HEDGING DECISIONS WHEN FORWARD MARKETS ARE INCOMPLETE

This paper examines the behaviour of the competitive firm that exports to two foreign countries under multiple sources of exchange rate uncertainty. There is a forward market between the home currency and one foreign country's currency, but there are no hedging instruments directly related to the other foreign country's currency. We show that the separation theorem holds when the firm optimally exports to the foreign country with the currency forward market. The full‐hedging theorem holds either when the firm exports exclusively to the foreign country with the currency forward market or when the relevant spot exchange rates are independent. In the case that the relevant spot exchange rates are positively (negatively) correlated in the sense of regression dependence, the firm optimally opts for a short (long) forward position for cross‐hedging purposes.     

CROSS‐HEDGING OF EXCHANGE RATE RISKS: A NOTE*

This note studies the optimal production and hedging decisions of a competitive international firm that exports to two foreign countries. The firm faces multiple sources of exchange rate uncertainty. Cross‐hedging is plausible in that one of the two foreign countries has a currency forward market. We show that the firm's optimal forward position is an over‐hedge, a full‐hedge or an under‐hedge, depending on whether the two random exchange rates are strongly positively correlated, uncorrelated or negatively correlated, respectively.     

LIQUIDITY RISK AND CORPORATE HEDGING WITH FUTURES

This paper examines the hedging behaviour of a value‐maximizing firm that exists for two periods. The firm faces uncertain income and is subject to tax asymmetries with no loss‐offset provisions. The firm has access to unbiased futures contracts in each period for hedging purposes. We impose a liquidity constraint on the firm. Specifically, whenever the net interim loss due to its first‐period futures position exceeds a predetermined threshold level, the firm is forced to terminate its risk management program and, therefore, is prohibited from trading the futures contracts in the second period. We show that the liquidity‐constrained firm optimally adopts a full‐hedge via its second‐period futures position to minimize the extent of the income risk and an under‐hedge via its first‐period futures position to limit the degree of the liquidity risk.     

Currency Options and Export-Flexible Firms

This paper examines the production and hedging decisions of a globally competitive firm under exchange rate uncertainty. The firm is risk averse and possesses export flexibility in that it can distribute its output to either the domestic market or a foreign market after observing the realized spot exchange rate. To hedge against its exchange rate risk exposure, the firm can trade fairly priced currency call options of an arbitrary strike price. We show that both the separation and the full‐hedging results hold if the strike price of the currency call options is set equal to the ratio of the domestic and foreign selling prices. Otherwise, neither result holds. Specifically, we show that the optimal level of output is always less than that of an otherwise identical firm that is risk neutral. Furthermore, an under‐hedge (over‐hedge) is optimal whenever the strike price of the currency call options is below (above) the ratio of the domestic and foreign selling prices.     

Currency hedging with options and futures

This paper examines the optimal hedging decision of a competitive exporting firm which faces concurrently hedgeable exchange rate risk and non-hedgeable price risk. We show that the hedging role of currency options is due to two distinct sources of non-linearity: (i) the multiplicative nature of the price and exchange rate risk; and (ii) the marginal utility function of the firm. In particular, we show that a long put option position is optimal when the price risk is negatively correlated with the exchange rate risk and/or the firm is prudent.     

Currency Hedging For Export-Flexible Firms *

This paper examines the production and hedging decisions of a competitive exporting firm under exchange rate uncertainty. The firm possesses export flexibility in that it can distribute its output to either the domestic market or a foreign market, after observing the true realization of the exchange rate. It is shown that the separation theorem does not hold under export flexibility, i.e., the firm's optimal output depends on the firm's preference and on the underlying exchange rate uncertainty. Furthermore, the export- flexible firm underhedges its exchange rate risk exposure in a currency forward market where in the forward exchange rate contains a non-positive risk premium. [D21, F31]     

Export-Flexible Firms and Forward Markets

This paper examines the production and hedging decisions of an exporting firm under exchange rate uncertainty. The firm is export flexible in that it can distribute its output to either the domestic market or a foreign market, after observing the realized spot exchange rate. The firm is a monopoly in the domestic market but a price-taker in the foreign market. It is shown that the separation theorem holds if selling exclusively in the domestic market is suboptimal even under the most unfavorable sport exchange rate. Otherwise, the firm's optimal output depends on its preference and on the underlying exchange rate uncertainty. Furthermore, the export-flexible firm underhedges its exchange rate risk exposure in a currency forward market wherein the forward exchange rate contains a non-positive risk premium. [D21, F31]     

Optimal Hedging Under Forward-Looking Behaviour*

The study focuses on the production and hedging behaviour of forward-looking risk-averse competitive firms. It is shown that there is separation between production and hedging. Optimal productin for a forward-looking firm is identical to that of an otherwise equivalent myopic firm. However, the optimal forward-looking hedge differs from the optimal myopic hedge. If forward prices are unbiased, full hedging is suboptimal when the firm is forward looking and output and material input prices are contemporaneously related. Furthermore, under certain conditions, the optimal forward-looking hedge under unbiased forward prices is strictly smaller than the full hedge.     

Price uncertainty,future markets and correlation

This paper examines the optimal trade and hedging decisions of a competitive exporting firm which faces concurrently hedgeable exchange rate risk and non‐hedgeable inflation risk. The macroeconomic interaction between exchange rate and domestic inflation rate risk is described by a state variable. The (strong) correlation is pivotal in determining the optimal risk management. It is shown how optimal hedging strategies are affected by state‐dependent preferences of the firm. The optimal hedge policy is to minimize the variation of marginal utility of final wealth across states of nature instead of minimizing the variance of final wealth.     

Operational and financial hedging for exporting firms

This paper examines the interaction between operational and financial hedging in the context of an internationally competitive but domestically monopolistic firm under exchange rate uncertainty. Operational hedging is modeled by letting the firm make its export decision after it has observed the true realization of the then prevailing spot exchange rate. Financial hedging, on the other hand, is modeled by allowing the firm to trade fairly priced exotic derivatives that are tailor-made for the firm's hedging need. We show that both operational and financial hedging unambiguously entice the firm into producing more. We further derive sufficient conditions under which operational hedging dominates (is dominated by) financial hedging in terms of promoting the firm's optimal output.     

Inflation Risk, Hedging, and Exports

This paper analyzes optimal production and hedging decisions of a risk-averse exporting firm in a developing country. The firm cares about real profits, since the spot exchange rate and the domestic price level are uncertain. It is demonstrated that a separation property holds although there are two sources of risk and only one hedging instrument exists. The authors examine the optimal risk management of the firm. In contrast to most hedging models, the real risk premium is important for the optimal hedging strategy.     

Exports and Indirect Hedging of Foreign Currency Risk

We present a model of a risk-averse competitive exporting firm under exchange rate risk. Direct hedging instruments are not available. However, there are domestic assets whose prices are correlated to the foreign currency. We consider a market for futures contracts in these domestic assets and investigate the firm's indirect hedging and export policy. It is shown that the availability of many financial instruments correlated with foreign exchange may, under some circumstances, provide the same results as a perfect hedge.
JEL Classification Numbers: F21, F31.     

Production and hedging decisions under regret aversion

In this paper, we investigate regret-averse firms' production and hedging behaviors. We first show that the separation theorem is still alive under regret aversion by proving that regret aversion is independent of the level of optimal production. On the other hand, we find that the full-hedging theorem does not always hold under regret aversion as the regret-averse firms take hedged positions different from those of risk-averse firms in some situations. With more regret aversion, regret-averse firms will hold smaller optimal hedging positions in an unbiased futures market. Furthermore, contrary to the conventional expectations, we show that banning firms from forward trading affects their production level in both directions.     

Exchange rate exposure: Evidence from China

This paper examines exchange rate exposure using a sample of Chinese firms. To measure RMB exchange rate volatility and jump risk, we apply the autoregressive conditional jump intensity (ARJI) model to the industry‐specific nominal effective exchange rate (I‐NEER) for 13 Chinese manufacturing industries over the period 2001 to 2017, We find that exchange rate risks do affect firm value at the industry level, and the effect is more significant for the jump risks that are more difficult to hedge and in the sample period when hedge activities are less likely to occur. Our results suggest that the exposure puzzle could be a result of the endogeneity of operative and financial hedging. Firm‐level analysis finds that exchange rate risk affects firm value for more than 20% of Chinese firms, and a firm's exchange rate exposure varies with the firm's characteristics.     

Optimal hedging with currency forwards,calls, and calls on forwards for the competitive exporting firm facing exchange rate uncertainty

We extend the well-known full hedge theorems of the hedging literature to random profits that are nonlinear in the random exchange rate. This arises when production flexibility is added to the standard model of the risk-averse exporting firm, where all production decisions have to be made before the exchange rate is known. Hence, hedging with currency derivatives that provide a linear payoff in the exchange rate can no longer provide a perfect hedge. Therefore forward selling is replaced by writing a certain call portfolio. Adding delayed revenue to the model induces the firm to sell calls on forwards. Because our generalized full hedge proposition is proved for random profits that might as well decrease in the exchange rate, the result is applicable to certain types of importing firms, too. — Given the absence of speculative motives on the part of the firm, it turns out that long-term investments in capital goods are chosen in risk-neutral manner.     

Hedging exchange rate risk: The multiperiod case

We analyse production and hedging in a multiperiod framework for a risk-averse exporting firm facing a random exchange rate. We extend the separation theorem to this multiperiod model. Our study shows that unbiased currency forward markets in all periods do not imply standard full hedging. Under some conditions, the firm tends to overhedge compared to the one-period hedging models.     

THE EFFECT OF FORWARD MARKETS ON MULTINATIONAL FIRMS

This paper presents a model of a risk averse multinational firm under exchange rate risk. The firm, which owns and controls assets in two countries, is engaged in production, sales and forward contracting whenever forward markets exist. First, we investigate the effects of exchange rate uncertainty without any risk sharing markets. It is shown that the firm internalizes missing hedging markets by increasing foreign production and lowering foreign sales. Therefore the firm hedges by repatriating foreign profits in the form of goods. Second, the implications of the existence of forward markets of global market decisions are discussed. It is shown that a separation theorem holds. This does not imply that the multinational firm shifts all the risk into the forward exchange market.     

Banking firm and hedging over the business cycle

This paper examines the behavior of a banking firm under risk. The banking firm can hedge its risk exposure by trading futures contracts. The banking firm is risk averse and possesses a utility function defined over its end-of-period income and a state variable that denotes the business cycle of the economy. We show that the banking firm optimally opts for an over-hedge or an under-hedge, depending on whether the returns on the futures contracts are negatively or positively correlated with the business cycle of the economy, respectively. Thus, the business cycle of the economy is an important determinant in shaping the banking firm’s optimal hedging strategy.