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Hedging and Nonlinear Risk Exposure

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  • Broll, Udo
  • Chow, Kong Wing
  • Wong, Kit Pong

Abstract

This paper documents some empirical evidence of nonlinear spot-futures exchange rates relationships and develops an expected utility model of an exporting firm to examine the associated economic implications. The model shows that the firm should export more (less) and adopt an over (under) hedge in an unbiased currency futures market if the spot-futures exchange rates relationships is convex (concave) rather than linear. When fairly priced currency options on futures are available, the firm should use them in conjunction with the currency futures so as to achieve better hedging against its nonlinear exchange rate risk exposure. This provides a rationale for the hedging role of options when the underlying uncertainty is nonlinear in nature. Copyright 2001 by Oxford University Press.

Suggested Citation

  • Broll, Udo & Chow, Kong Wing & Wong, Kit Pong, 2001. "Hedging and Nonlinear Risk Exposure," Oxford Economic Papers, Oxford University Press, vol. 53(2), pages 281-296, April.
  • Handle: RePEc:oup:oxecpp:v:53:y:2001:i:2:p:281-96
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    References listed on IDEAS

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    1. Stiglitz, J E, 1979. "Equilibrium in Product Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 69(2), pages 339-345, May.
    2. Steven Salop & Joseph Stiglitz, 1977. "Bargains and Ripoffs: A Model of Monopolistically Competitive Price Dispersion," Review of Economic Studies, Oxford University Press, vol. 44(3), pages 493-510.
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    5. Seade, Jesus K, 1980. "On the Effects of Entry," Econometrica, Econometric Society, vol. 48(2), pages 479-489, March.
    6. Louis L. Wilde & Alan Schwartz, 1979. "Equilibrium Comparison Shopping," Review of Economic Studies, Oxford University Press, vol. 46(3), pages 543-553.
    7. George A. Akerlof, 1970. "The Market for "Lemons": Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, Oxford University Press, vol. 84(3), pages 488-500.
    8. Michael Spence, 1973. "Job Market Signaling," The Quarterly Journal of Economics, Oxford University Press, vol. 87(3), pages 355-374.
    9. Robert Wilson, 1977. "A Bidding Model of Perfect Competition," Review of Economic Studies, Oxford University Press, vol. 44(3), pages 511-518.
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    Cited by:

    1. Broll, Udo & Eckwert, Bernhard, 2011. "Information value, export and hedging," Dresden Discussion Paper Series in Economics 03/11, Technische Universität Dresden, Faculty of Business and Economics, Department of Economics.
    2. Broll, Udo & Wong, Kit Pong, 2002. "Optimal full-hedging under state-dependent preferences," The Quarterly Review of Economics and Finance, Elsevier, vol. 42(5), pages 937-943.
    3. Udo Broll & Kit Wong, 2010. "Banking firm and hedging over the business cycle," Portuguese Economic Journal, Springer;Instituto Superior de Economia e Gestao, vol. 9(1), pages 29-33, April.
    4. Aysun, Uluc & Guldi, Melanie, 2011. "Exchange rate exposure: A nonparametric approach," Emerging Markets Review, Elsevier, vol. 12(4), pages 321-337.
    5. Broll, Udo & Wong, Kit Pong, 2003. "Capital structure and the firm under uncertainty," Dresden Discussion Paper Series in Economics 20/03, Technische Universität Dresden, Faculty of Business and Economics, Department of Economics.
    6. Gilroy, Bernard Michael & Broll, Udo, 2005. "Managing Credit Risk with Credit Derivatives," MPRA Paper 17678, University Library of Munich, Germany.
    7. Broll, Udo & Eckwert, Bernhard & Wong, Kit Pong, 2010. "International trade and the role of market transparency," Dresden Discussion Paper Series in Economics 08/10, Technische Universität Dresden, Faculty of Business and Economics, Department of Economics.
    8. Lien, Donald & Wong, Kit Pong, 2004. "Optimal bidding and hedging in international markets," Journal of International Money and Finance, Elsevier, vol. 23(5), pages 785-798, September.

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