Corporate Risk Management in Balance-Sheet Triggered Currency Crises

This chapter deals with the role of corporate risk management for macroeconomic stability. Firms’ balance sheets and the financing-investment relationship are at the center of this study. The interrelation of firms’ balance sheets and investment has been extensively investigated in connection with monetary policy transmission and, in particular, in connection with the balance sheet channel. Bernanke and Gertler (1990, 1995), Bernanke and Lown (1991), Calomiris and Hubbard (1990), Gertler and Gilchrist (1994), and Onliner and Rudebusch (1996) model investment as being sensitive to current cash flows and net worth.1 A decrease in a firm’s cash flow and, hence, in a firm’s net worth will decrease its ability to borrow. This leads to investment contraction. An initial monetary shock, which worsens credit market conditions, can therefore result in large cycles as described by the financial accelerator.2 The role of balance sheets in currency and financial crises are also well recognized.3 Mishkin (1998, p. 13) for example states that: “(...), there is another factor affecting balance sheets that can be extremely important in precipitating financial instability in emerging market countries that is not operational in most industrialized countries: unanticipated exchange rate depreciation or devaluation. Because of uncertainty about the future value of the domestic currency, many nonfinancial firms, banks and governments in emerging market countries find it much easier to issue debt if the debt is denominated in foreign currency. (...) With debt contracts denominated in foreign currency, when there is an unanticipated depreciation or devaluation of the domestic currency, the debt burden of domestic firms increases.”