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International trade, hedging and the demand for forward contracts

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  • Eisenschmidt, Jens
  • Wälde, Klaus

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 aforementioned 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 nvestment 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 Dresden University of Technology, Faculty of Business and Economics, Department of Economics in its series Dresden Discussion Paper Series in Economics with number 19/03.

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Date of creation: 2003
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Handle: RePEc:zbw:tuddps:1903

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Keywords: forward contracts; terms of trade uncertainty; hedging;

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  1. Obstfeld, M., 1998. "Risk and Exchange Rate," Papers 193, Princeton, Woodrow Wilson School - Public and International Affairs.
  2. Peree, Eric & Steinherr, Alfred, 1989. "Exchange rate uncertainty and foreign trade," European Economic Review, Elsevier, vol. 33(6), pages 1241-1264, July.
  3. Viaene, J-M. & De Vries, C.G., 1989. "International Trade And Exchange Rate Volatility," Papers 8905, Erasmus University of Rotterdam - Institute for Economic Research.
  4. Zilcha, Itzhak & Broll, Udo, 1992. "Optimal hedging by firms with multiple sources of risky revenues," Economics Letters, Elsevier, vol. 39(4), pages 473-477, August.
  5. 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.
  6. Agathe Cote, 1994. "Exchange Rate Volatility and Trade," International Trade 9406001, EconWPA, revised 23 Jun 1994.
  7. 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.
  8. Harald Hau & Hélène Rey, 2006. "Exchange Rates, Equity Prices, and Capital Flows," Review of Financial Studies, Society for Financial Studies, vol. 19(1), pages 273-317.
  9. Maddison, Angus, 1987. "Growth and Slowdown in Advanced Capitalist Economies: Techniques of Quantitative Assessment," Journal of Economic Literature, American Economic Association, vol. 25(2), pages 649-98, June.
  10. Bacchetta, Philippe & van Wincoop, Eric, 1998. "Does Exchange Rate Stability Increase Trade and Capital Flows?," CEPR Discussion Papers 1962, C.E.P.R. Discussion Papers.
  11. 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.
  12. 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.
  13. Wei, Shang-Jin, 1999. "Currency hedging and goods trade," European Economic Review, Elsevier, vol. 43(7), pages 1371-1394, June.
  14. Peter B. Clark, 1973. "Uncertainty, Exchange Risk, And The Level Of International Trade," Economic Inquiry, Western Economic Association International, vol. 11(3), pages 302-313, 09.
  15. Eldor, Rafael & Zilcha, Itzhak, 1987. "Discriminating Monopoly, Forward Markets and International Trade," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 28(2), pages 459-68, June.
  16. Adam-Muller, Axel F. A., 2000. "Hedging price risk when real wealth matters," Journal of International Money and Finance, Elsevier, vol. 19(4), pages 549-560, August.
  17. Ethier, Wilfred, 1973. "International Trade and the Forward Exchange Market," American Economic Review, American Economic Association, vol. 63(3), pages 494-503, June.
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