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Publisher Info
Paper provided by Bank of Canada in its series Working Papers with number
02-34.
Length: 40 pages Abstract: This paper examines the daily hedging and risk-management practices of financial intermediaries in the Canadian foreign exchange (FX) market. Results reported in this paper suggest that financial institutions behave similarly when managing their market risk exposure. In particular, dealing banks do not fully hedge their spot market risk. The results reported support arguments by Stulz (1996) and Froot and Stein (1998) that the amount of hedging will depend on a firm's comparative advantage in bearing risk. While the extent of hedging is found to depend on market volatility and the magnitude of their risk exposure, the uniqueness of the dataset employed in this paper allows for an explicit test of the various sources of comparative advantage that dealing banks in the FX markets have in their role as market-makers. Private information via customer order flow, guaranteed access to liquidity, and the capital-allocation structure of a dealer's financial institution are potential sources of comparative advantage to dealing banks in the FX market. A model with private information and an imperfectly competitive environment is provided to illustrate hedging when informed agents in a multiple security market behave strategically. Empirical results suggest that dealing banks only selectively hedge speculative positions taken in the spot market in the forward market. Findings also suggest that dealing banks share in the risk exposure of the spot market's net position without simultaneously hedging this risk. Date of creation: 2002 Date of revision: Handle: RePEc:bca:bocawp:02-34
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
H. Henry Cao & Richard K. Lyons & Martin D.D. Evans, 2003.
"Inventory Information,"
NBER Working Papers
9893, National Bureau of Economic Research, Inc.
[Downloadable!] (restricted)
Other versions:
H. Henry Cao & Martin D. Evans & Richard K. Lyons, 2006.
"Inventory Information,"
Journal of Business,
University of Chicago Press, vol. 79(1), pages 325-364, January.
[Downloadable!]