Currency Hedging Research Articles

The Hedging Channel of Exchange Rate Determination

Abstract We propose the currency hedging channel that connects countries’ external imbalances to their exchange rate behavior. We present a model in which investors increase their currency hedging during periods of financial distress in proportion to their net foreign asset exposure. This behavior coupled with constrained financial intermediation explains observed relationships between gradually adjusting external imbalances and volatile spot and forward exchange rates. We find empirical support for the hedging channel in both the conditional and unconditional moments of exchange rates, option prices, and countries’ uses of Federal Reserve swap lines. (JEL E44, F31, F32, F41, G11, G15)

Hedging political risk in international portfolios

We show that internationally diversified portfolios carry sizeable political risk premia and expose investors to tail risk. We obtain political efficient frontiers with and without hedging political risk using a portfolio selection model for skewed distributions and develop a new asymptotic inference test to compare portfolio performance. Politically hedged portfolios outperform a broad market index and the equally weighted portfolio for US, Eurozone, and Japanese investors. Political risk hedging is not subsumed by currency hedging, and the diversification gains of politically hedged portfolios persist under currency hedging and transaction cost frictions. Hedging political risk induces equity home bias but does not fully explain the puzzle.

Over-hedging in the shadow of weaker litigation threat

Using the staggered adoption of universal demand (UD) laws by U.S. states over the period 1997–2010 as a quasi-natural experiment, we examine the impacts of weakened shareholder litigation rights on corporate financial risk management. We find that firms facing reduced litigation threats post-UD law adoption engage in more currency hedging, coupled with decreases in firm value. The increase in risk management is particularly pronounced for firms with higher pre-existing litigation risk, weaker governance structures, and greater managerial entrenchment. Our evidence suggests that diminished shareholder litigation threat incentivizes managers to over-hedge to protect their own interests rather than maximize shareholder value.

The nexus between economic growth and conditional exchange rate volatility: evidence from emerging economies

PurposeThe purpose of this paper was to examine the nexus between conditional exchange rate volatility and economic growth in BRICS countries. Further, the dynamic causation between economic growth and exchange rate volatility is also examined.Design/methodology/approachWe employed three techniques, namely, dynamic panel models, static panel models and Dumitrescu and Hurlin (DH) panel causality test to examine the economic growth–conditional exchange rate volatility nexus in BRICS countries.FindingsThe overall results showed that conditional exchange rate volatility has a negative and significant effect on economic growth. Interestingly, the results showed that whenever the exchange rate volatility exceeds the 0–1.54 range, the economic growth of BRICS is reduced, on average, by 5%. Further, the results of the causality test reconciled with that of ARDL wherein unidirectional causality from exchange rate volatility, exports, labour force and gross capital formation to economic growth was found.Research limitations/implicationsThe urgent recommendation is to develop and align fiscal, monetary, trade and exchange rate policies, either through creating a common currency region or through coordinated measures to offset volatility and trade risks in the long run. Further, to offset the impact of excessive exchange rate changes, BRICS economies can set up currency hedging systems, implement temporary capital controls during periods of extreme volatility or create currency swap agreements with other nations or regions. Last, but not least, investment and labour policies that are coherent and well-coordinated can support market stabilisation, promote investment and increase worker productivity and job prospects.Originality/valueResearchers hold contrasting views regarding the effect of exchange rate volatility on economic growth. Some researchers claim that exchange rate volatility reduces growth, and several shreds of empirical evidence claim that lower exchange rate volatility is linked with an increase in economic growth, at least in the short run. However, the challenge lies in establishing the optimal range beyond which exchange rate volatility becomes detrimental to economic growth. The present study contributes to this aspect by seeking to identify the optimal spectrum beyond which excessive shifts in exchange rate volatility negatively affect economic growth, or endeavors to define the acceptable spectrum within which these fluctuations actually boost growth. To the best of our knowledge, this study is the first to analyse the given research area. The present study used a dummy variable technique to capture the impact of permissible exchange rate band on the economic growth.

Стратегии выхода российских организаций на международные рынки в изменившихся внешнеэкономических условиях

The change in the system of world economic communications as a result of sanction policy towards Russia and its allied countries forces enterprises and organizations to prove strategies of entry into foreign markets for the purpose of income generation and inclusion in new value chains. Therefore, the purpose of this research is the comparative analysis of factors and assessment of the application of international market entry strategies of Russian IT companies. Qualitative and quantitative methods of economic research were applied to achieving this goal. Qualitative methods included PESTEL analysis, situation and comparative analysis. Quantitative methods included the cost-benefit method, statistical techniques and economic analysis methods. Tabular and graphic approaches are used for text visualization. In this research the factors influencing organizations activity in the international sphere and also the main foreign market entry strategies of IT companies were analyzed. Comparative analysis revealed benefits and shortcomings of each strategy, taking into account modern forms of business and currency risks. For the Russian IT company producing software three strategies were evaluated: export, franchising and direct investments. The choice of the IT industry for considering international market entry strategies of Russian organizations is proven. It is necessary to separate the development of new technologies and infrastructure, existence of financial resources and pressure of economic sanctions from the factors influencing this process. Of the three strategies analyzed, the lowest-cost and lowest-profit strategy was the franchising strategy; it can be used when there is a shortage of financial resources. For “growth hacking” the expensive, but highly profitable strategy of direct investment taking into account currency hedging is applicable. Proceeding from the analysis of the influencing factors and legal conditions of the Russian Federation it is expedient to follow the strategy of average profitable export for ensuring company development. The practical application of strategies for organizations to enter foreign markets is a multifaceted object of research that requires a comprehensive analysis of various aspects of business expansion. The received results will help companies make weighed decisions when choosing the optimum strategy for expanding their business in the international market.

Analisis Resiko Operasional dalam Industri Travel Yuk Kita Tour Untuk Meningkatkan Efisiensi dan Kepuasan Pelanggan

This study aims to investigate the identification, assessment, and control of operational risks in the travel industry, with a focus on PT Yuk Kita Tour. Direct observation and interview methods are used to identify the risks faced by the company. Risk assessment is conducted by considering the likelihood of occurrence and its impact on the company's operations, followed by appropriate mitigation strategies. The analysis results show that risks such as online booking system disruptions, lack of staff training, currency exchange rate fluctuations, regulatory changes, natural disasters, disease outbreaks, transportation delays, and terrorism threats affect operational efficiency and customer satisfaction.To control these risks, PT Yuk Kita Tour implements a comprehensive mitigation strategy, including improved cybersecurity systems, staff training programs, currency hedging strategies, active regulatory monitoring, travel insurance, strict health policies, cooperation with transportation operators, and clear security information to customers. The implementation of these risk control strategies has had a positive impact on the company's performance, with year-on-year increases in revenue and customer satisfaction. This study provides insights into the importance of operational risk management in the travel industry and demonstrates that a proactive approach to risk identification, assessment, and control is possible. This study provides insight into the importance of operational risk management in the travel industry and demonstrates that a proactive approach to risk identification, assessment, and control can improve operational efficiency and customer satisfaction. The practical implication of this study is the importance of continuously monitoring existing risks, adapting control strategies, and involving stakeholders in risk management to ensure sustainable business continuity and superior customer service in a dynamic business environment.

Foreign investments of Japanese life insurance companies

We investigate Japanese life insurance companies’ investment returns or volatilities and their discretionary decisions on foreign portfolio investments. These decisions include the proportion of foreign investments in the companies’ proprietary investments and the currency risk hedge. We consider the “carry trade” scenario when the market favors investing in high-yield currencies by borrowing the Japanese yen. We establish three results. First, the currency hedge relates positively to the investment returns under the carry trade scenario but negatively otherwise. Second, the proportion of foreign investments relates positively to the investment returns. Third, the investment returns significantly decrease under the carry trade scenario.

Do customers matter in currency hedging policies? Evidence from product warranties

AbstractUsing a data set of US manufacturing firms with sales from foreign operations, we find that firms' currency hedging activities vary with their warranty obligations. The positive link of warranty obligations to currency hedging policies prevails in financially more constrained firms, companies facing fiercer product market competition and corporations producing more unique products. Our results suggest that firms are likely to incorporate their contractual commitments to customers into their currency hedging activities, especially when their failures to honor these commitments are more likely or costly.

Dynamic currency hedging with non-Gaussianity and ambiguity

This paper introduces a non-Gaussian dynamic currency hedging strategy for globally diversified investors with ambiguity. It provides theoretical and empirical evidence that, under the stylized fact of non-Gaussianity of financial returns and for a given optimal portfolio, the investor-specific ambiguity can be estimated from historical asset returns without the need for additional exogenous information. Acknowledging non-Gaussianity, we compute an optimal ambiguity-adjusted mean-variance (dynamic) currency allocation. Next, we propose an extended filtered historical simulation that combines Monte Carlo simulation based on volatility clustering patterns with the semi-parametric non-normal return distribution from historical data. This simulation allows us to incorporate investor's ambiguity into a dynamic currency hedging strategy algorithm that can numerically optimize an arbitrary risk measure, such as the expected shortfall. The out-of-sample backtest demonstrates that, for globally diversified investors, the derived non-Gaussian dynamic currency hedging strategy is stable, robust, and highly risk reductive. It outperforms the benchmarks of constant hedging as well as static/dynamic hedging approaches with Gaussianity in terms of lower maximum drawdown and higher Sharpe and Sortino ratios, net of transaction costs.

Firms, Currency Hedging and Financial Derivatives *

Firms, Currency Hedging and Financial Derivatives *

Hedging with Financial Derivatives and Firm Performance of Consumer Goods Companies Listed on Nigeria Exchange Group

Hedging with derivatives is a common strategy to manage foreign currency risk, interest rate risk, commodity price risk and mitigating potential losses or gains that might arise from fluctuations in the market. This study was conducted to reveal findings on the impact of hedging activities using derivatives on the financial performance of consumer goods companies listed on Nigerian Exchange (NGX). The independent variables for the study are foreign currency hedge, interest rate hedge and commodity price hedge. Data were collected from Ten (20) consumer goods companies quoted on Nigerian Exchange covering 2018 to 2022 financial years. The results of hypothesis testing reveal that hedging with derivatives has a significant effect on firm performance. This findings supports the findings of Alan and Gupta (2018) and Lenee and Oki (2017), who conclude that the use of hedging can minimize the volatility and has a positive effect on firm value. As a general recommendations, it is important to note that regulating the derivatives market is essential to ensure stability, transparency, prevent excessive speculation, manipulation, and enhance fair practices in the financial system.

Weathering exchange rates: estimating the effect of climate change vulnerability on foreign currency hedging using a text-based approach

PurposeThe authors investigate whether firm-specific vulnerability to climate change influences foreign exchange hedging, using a novel text-based measure of firm-level climate change exposure generated by state-of-the-art machine-learning algorithms.Design/methodology/approachThe authors' empirical analysis includes firm-fixed effects, random-effects regressions, propensity score matching (PSM), entropy balancing, an instrumental-variable analysis and using an exogenous shock as a quasi-natural experiment.FindingsThe authors' findings suggest that greater climate change exposure brings about a significant reduction in exchange rate hedging. Companies more exposed to climate change may invest significant resources to address climate change risk, such that they have fewer resources available for currency risk management. Additionally, firms seriously coping with climate change risk may view exchange rate risk as relatively less important in comparison to the risk posed by climate change. Notably, the authors also find that the negative effect of climate change exposure on currency hedging can be specifically attributed to the regulatory aspect of climate change risk rather than the physical dimension, suggesting that companies view the regulatory dimension of climate change as more critical.Originality/valueRecent studies have demonstrated that climatic fluctuations represent one of the most recent sources of unpredictability, thereby impacting the economy and financial markets (Barnett et al., 2020; Bolton and Kacperczyk, 2020; Engle et al., 2020). The authors' study advances this field of research by revealing that company-specific exposure to climate change serves as a significant determinant of corporate currency hedging, thus expanding the existing knowledge base.

The Impact of Disclosing Successive Adjustments to Foreign Exchange Rates on Stock Profitability

The Aim of this research is to analyze the impact of exchange rate Adjustments on stock returns in Egypt, and the impact of these changes depends on the analytical theoretical study approach to achieve the research objectives by reviewing what was stated in previous studies related to the research variables. The research focused on Egypt’s modern experience in exchange rate policies. As the research was conducted during the period from (2019-2023), it appears that positive and negative changes in the exchange rates of the Egyptian pound to the US dollar have a significant impact on stock returns, whether in the short or long term. It was found that currency depreciation tends to have a stronger impact on stock returns than the effect of currency appreciation, as the research concluded that exchange rate changes are affected by external variables, which affects stock returns, and that disclosures about exchange rate changes are necessary to avoid being subject to deterioration in stock returns. Practical Implications The results provide important insights for investors, regulators, and policymakers. With the devaluation of the local currency negatively impacting stock returns, investors should consider implementing appropriate currency hedging strategies to reduce the risks of currency depreciation, and thus maintain the expected rate of return on investments denominated in Egyptian pounds. Keywords: Foreign Exchange Rates – Stock Returns – Egyptian Stock Exchange

Currency hedging. The case study Nestlé Suisse SA

Globalization has opened a world market that allows us to trade. These exchanges are now counted in billions of Swiss francs (CHF). (Grossbard, 2023) Indeed, many companies buy and sell currencies every day in order to settle their transactions. For many companies, the price of foreign currencies has an impact on their results. This impact is not controllable and can be very volatile and unpredictable. Companies are all looking to minimize the uncertainty of foreign exchange losses and therefore find the best ways to avoid such accidents. Several means exist such as the technical strategy of currency hedging. This paper will illustrate how an international company works when it comes to forwards. There will be a fictional case study that will show the impact of the war in Ukraine in currency hedging.

Currency hedging. The case study Nestlé Suisse SA

Currency hedging. The case study Nestlé Suisse SA

Priorities for the G20 Finance Track

Emerging markets and developing economies are currently facing major challenges from global shocks, including a slowdown in global growth; food and energy price increases; decline in risk appetite of international investors; unsustainable debts in low-income countries; and ongoing climate risks. National policies have not sufficed to meet these challenges. Efforts at the national level must be complemented by changes in the global economic and financial architecture designed to make the world a safer place. In this article, we focus on the financial aspects of such reforms. The financial agenda as we see it has seven key elements: (i) reform of central bank swap lines, (ii) reform of IMF-contingent credit lines, (iii) SDR reallocation, (iv) reform of credit rating agencies, (v) creation of currency hedging instruments, (vi) inclusion of climate-resilient debt clauses in new debt instruments and (vii) steps to streamline the debt restructuring process. We detail this agenda and urge the G20 members to implement the recommended measures. JEL Codes: E44, E58, E61, F34, F36, F38

Lending Relationships and Currency Hedging

Lending Relationships and Currency Hedging

Do Customers Matter in Currency Hedging Policies? Evidence from Product Warranties

Do Customers Matter in Currency Hedging Policies? Evidence from Product Warranties

ESG Green Equity Finance Risk and Links in Mexico: Conditional Volatility and Markov Switching Vector Analyses

We analyze the differential influence of Mexican oil price, exchange rate and S&P 500 Index on the Mexican Stock Exchange: S&P/BMV IPC ESG Tilted Index (sustainable stock market index), and on the S&P/BMV IPC (General stock market index) in two different regimes. First, we estimate the conditional volatility of the series using a univariate GARCH model under the t-Student distribution. Second, a Markov Switching Vector Autoregressive model is developed. The evidence identifies sustainable asset performance, risk, and interaction with other regular assets. The sustainable index is more vulnerable to the foreign exchange market and to the U.S. stock market, especially in periods of turbulence. Only the S&P 500 shows a statistically significant impact on the overall Mexican index, for both states high and low volatility. Oil prices do not have a significant impact on the Mexican indices analyzed. Evidence allows us to recommend a currency hedging in ESG investments. Originality relies on empirical approaches and the study of ESG index in an emerging market. Limitations are related with the scarce information and limited access to ESG factors data. We conclude that investment strategies should be different during calm and turmoil periods.

Exchange rate regime in a crisis: The case of Azerbaijan

This study aims to substantiate the practicality of establishing a fixed exchange rate (FER) under external shocks to the Azerbaijani economy. Using regression analysis, principal component analysis, and the Granger causality test, we substantiated the inexpediency of a fixed FER for the manat (the national currency) due to: the ineffective fiscal and monetary policy of the state, weak integration into the U.S. economy, distrust of the manat in the population, and the weakness of currency hedging. Artificial retention of a FER will lead to devaluation and chronic economic recession (inflation growth, a decrease in real incomes of the population, a reduction of GDP per capita, and an increase in unemployment). It is substantiated that an increase in public confidence in the national currency should become the basis for the transition to a floating exchange rate (FER) for the manat as it will help to get the actual value of the manat.