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International Trade, Hedging and the Demand for Forward Contracts

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  • Jens, EISENSCHMIDT

    (Technische Universitat Dresden, Germany)

  • Klaus, WAELDE

    (University of Dresden and UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de recherches économiques et sociales, IRES)

Abstract

There is a huge literature on the effects of uncertainty on trade levels. One very strong result of that literature is that uncertainty should not matter, as long as well developed forward markets exist. The empirical implications of this result, however, are hard to find in the data. We model terms of trade uncertainty in a small open economy with uncertainty stemming from abroad and derive the equilibrium demand for forward contracts. It turns out that risk averse agents will not buy forwards at an actuarially fair price, thus rendering both the full-hedge theorem and the separation theorem of the afore-mentioned literature obsolete. Using real world data for Germany we calibrate our model. We find that in equilibrium risk averse agents will buy forward cover only for investment reasons. The amount of forwards purchased is around 20% of equilibrium imports. This is broadly in accordance with empirical observed ratios.

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Paper provided by Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES) in its series Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) with number 2003022.

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Length: 26
Date of creation: 01 Nov 2003
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Handle: RePEc:ctl:louvir:2003022

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  1. Wei, Shang-Jin, 1999. "Currency hedging and goods trade," European Economic Review, Elsevier, vol. 43(7), pages 1371-1394, June.
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  3. Kawai, Masahiro & Zilcha, Itzhak, 1986. "International trade with forward-futures markets under exchange rate and price uncertainty," Journal of International Economics, Elsevier, vol. 20(1-2), pages 83-98, February.
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  14. Ethier, Wilfred, 1973. "International Trade and the Forward Exchange Market," American Economic Review, American Economic Association, vol. 63(3), pages 494-503, June.
  15. Viaene, Jean-Marie & de Vries, Casper G., 1992. "International trade and exchange rate volatility," European Economic Review, Elsevier, vol. 36(6), pages 1311-1321, August.
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  17. Viaene, Jean-Marie & Zilcha, Itzhak, 1998. "The Behavior of Competitive Exporting Firms under Multiple Uncertainty," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(3), pages 591-609, August.
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