Exchange Rate Risk Management: Evidence from East Asia

Abstract

The recent East Asian financial crisis provides a natural experiment for investigating foreign exchange risk management by nonfinancial corporations. During this period, the financial crisis exposed local firms to large depreciations in exchange rates and reduced access to foreign capital. The authors explore the exchange rate hedging practices of firms that hedged exposure to foreign debt in eight East Asian countries between 1996 and 1998. They identify and characterize East Asian companies that used foreign currency derivatives, documenting differences in size, financial characteristics, and exposure to domestic and foreign debt. They investigate the factors improtant in the use of foreign currency derivatives. Unlike studies of US firms, they find limited support for existing theories of optimal hedging. Instead, they find that firms use foreign earnings as a substitute for hedging with derivatives. And they find evidence that firms engage inselectivehedging. They investigate the relative performance of hedgers during and after the crisis. They find no evidence that East Asian firms eliminated their foreign exchange exposure by using derivatives. Firms that used derivatives before the crisis performed just as poorly as nonhedgers during the crisis. After the crisis, firms that hedged performed somewhat better than nonhedgers, but this result appears to be explained by a larger post-crisis currency exposure for hedgers (an exchange rate risk premium), which had limited access to derivatives during this period.