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Hedging speculation, and investment in balance-sheet triggered currency crises

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  • Röthig, Andreas
  • Semmler, Willi
  • Flaschel, Peter

Abstract

This paper explores the linkage between corporate risk management strategies, investment, and economic stability in an open economy with a flexible exchange rate regime. Firms use currency futures contracts to manage their exchange rate exposure – caused by balance sheet effects as in Krugman (2000) – and therefore their investments’ sensitivity to currency risk. We find that, depending on whether futures contracts are used for risk reduction (i.e., hedging) or risk taking (i.e., speculation), the implied magnitudes of recessions and booms are decreased or increased. Corporate risk management can therefore substantially affect economic stability on the macrolevel.

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File URL: http://www.download.tu-darmstadt.de/wi/vwl/ddpie/ddpie_168.pdf
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Bibliographic Info

Paper provided by Darmstadt Technical University, Department of Business Administration, Economics and Law, Institute of Economics (VWL) in its series Darmstadt Discussion Papers in Economics with number 25377.

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Date of creation: Mar 2006
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Publication status: Published in Darmstadt Discussion Papers in Economics . 168 (2006-03)
Handle: RePEc:dar:ddpeco:25377

Note: for complete metadata visit http://tubiblio.ulb.tu-darmstadt.de/25377/
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Related research

Keywords: Mundell-Fleming-Tobin model; foreign-debt financed investment; currency crises; real crises; currency futures; hedging; speculation;

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  1. Stulz, René M., 1984. "Optimal Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 19(02), pages 127-140, June.
  2. Smith, Clifford W. & Stulz, René M., 1985. "The Determinants of Firms' Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(04), pages 391-405, December.
  3. Froot, Kenneth A & Scharfstein, David S & Stein, Jeremy C, 1993. " Risk Management: Coordinating Corporate Investment and Financing Policies," Journal of Finance, American Finance Association, vol. 48(5), pages 1629-58, December.
  4. Kenneth A. Froot & David S. Scharfstein & Jeremy C. Stein, 1994. "A Framework For Risk Management," Journal of Applied Corporate Finance, Morgan Stanley, vol. 7(3), pages 22-33.
  5. Peter Tufano, 1998. "Agency Costs of Corporate Risk Management," Financial Management, Financial Management Association, vol. 27(1), Spring.
  6. Rui Albuquerque, 2004. "Optimal Currency Hedging," Finance 0405010, EconWPA.
  7. Gerald D. Gay & Jouahn Nam, 1998. "The Underinvestment Problem and Corporate Derivatives Use," Financial Management, Financial Management Association, vol. 27(4), Winter.
  8. Fatemi, Ali & Luft, Carl, 2002. "Corporate risk management: Costs and benefits," Global Finance Journal, Elsevier, vol. 13(1), pages 29-38.
  9. Beatty, Anne, 1999. "Assessing the use of derivatives as part of a risk-management strategy," Journal of Accounting and Economics, Elsevier, vol. 26(1-3), pages 353-357, January.
  10. Nance, Deana R & Smith, Clifford W, Jr & Smithson, Charles W, 1993. " On the Determinants of Corporate Hedging," Journal of Finance, American Finance Association, vol. 48(1), pages 267-84, March.
  11. Guay, Wayne R., 1999. "The impact of derivatives on firm risk: An empirical examination of new derivative users1," Journal of Accounting and Economics, Elsevier, vol. 26(1-3), pages 319-351, January.
  12. DeMarzo, Peter M & Duffie, Darrell, 1995. "Corporate Incentives for Hedging and Hedge Accounting," Review of Financial Studies, Society for Financial Studies, vol. 8(3), pages 743-71.
  13. Paul Krugman, 2000. "Crises : the price of globalization?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 75-106.
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Cited by:
  1. Semmler, Willi & Bernard, Lucas, 2012. "Boom–bust cycles: Leveraging, complex securities, and asset prices," Journal of Economic Behavior & Organization, Elsevier, vol. 81(2), pages 442-465.

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