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Cross-hedging of correlated exchange rates

Author

Listed:
  • Broll, Udo
  • Wong, Kit Pong

Abstract

This paper examines the behavior of a competitive exporting firm that exports to two foreign countries under multiple sources of exchange rate uncertainty. The firm has to cross-hedge its exchange rate risk exposure because there is only a forward market between the domestic currency and one foreign country's currency. When the firm optimally exports to both foreign countries, we show that the firm's production decision is independent of the firm's risk attitude and of the underlying exchange rate uncertainty. We show further that the firm's optimal forward position is an over-hedge or an under-hedge, depending on whether the two random exchange rates are positively or negatively correlated in the sense of expectation dependence.

Suggested Citation

  • Broll, Udo & Wong, Kit Pong, 2011. "Cross-hedging of correlated exchange rates," Dresden Discussion Paper Series in Economics 04/11, Technische Universität Dresden, Faculty of Business and Economics, Department of Economics.
    • Handle: RePEc:zbw:tuddps:0411
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    References listed on IDEAS

    as
    1. Broll, Udo & Wong, Kit Pong & Zilcha, Itzhak, 1999. "Multiple Currencies and Hedging," Economica, London School of Economics and Political Science, vol. 66(264), pages 421-432, November.
    2. Anderson, Ronald W & Danthine, Jean-Pierre, 1981. "Cross Hedging," Journal of Political Economy, University of Chicago Press, vol. 89(6), pages 1182-1196, December.
    3. Broll, Udo & Eckwert, Bernhard, 1996. "Cross-Hedging of Exchange-Rate Risk," Review of International Economics, Wiley Blackwell, vol. 4(3), pages 282-286, October.
    4. Benninga, Simon & Eldor, Rafael & Zilcha, Itzhak, 1985. "Optimal international hedging in commodity and currency forward markets," Journal of International Money and Finance, Elsevier, vol. 4(4), pages 537-552, December.
    5. Broll, Udo & Zilcha, Itzhak, 1992. "Exchange rate uncertainty, futures markets and the multinational firm," European Economic Review, Elsevier, vol. 36(4), pages 815-826, May.
    6. 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.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    correlated exchange rates; cross-hedging; exports; production;
    All these keywords.

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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