Foreign exchange liberalization and exchange rate exposure: Firm-level evidence of the Japanese Automobile Industry

This paper empirically examines the effect of the drastic amendment of the Foreign Exchange and Foreign Trade Act (FEFTA) in 1998 on the exchange rate exposure of ten Japanese automobile firms. By conducting panel estimation using the firm-level explanatory variables constructed originally, we find that (1) the degree of automobile firms’ exchange rate exposure increased significantly during the post-1998 FEFTA amendment period; (2) however, more profitable automobile firms with higher ROE and facing larger exchange rate volatility could reduce their exposures after the 1998 FEFTA amendment because they could conduct efficient operational hedging through expanding supply chains and more readily utilize efficient hedging instruments to reduce group-wide foreign exchange risk; (3) more sales in and exports to Southeast Asian countries significantly reduced automobile firms’ exposures, because they tended to invoice their exports to Southeast Asian countries not in USD but in the yen. Our findings would be insightful for Asian economies that move gradually toward foreign exchange liberalization. Efficient operational and financial hedging, as well as invoice currency choice, significantly affect the degree of exposure after foreign exchange liberalization.