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Hedging, Speculation, and Investment in Balance-Sheet Triggered Currency Crises

  • Andreas Röthig

    (Institute of Economics, Darmstadt University of Technology and Center for Empirical Marcroeconomics, University of Bielefeld)

  • Willi Semmler

    (Center for Empirical Marcroeconomics, University of Bielefeld and New School University New York)

  • Peter Flaschel

    (Center for Empirical Marcroeconomics, University of Bielefeld)

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.business.uts.edu.au/qfrc/research/research_papers/rp173.pdf
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Paper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 173.

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Length: 32
Date of creation: 01 Feb 2006
Date of revision:
Handle: RePEc:uts:rpaper:173
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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. Peter Tufano, 1998. "Agency Costs of Corporate Risk Management," Financial Management, Financial Management Association, vol. 27(1), Spring.
  3. 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.
  4. 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.
  5. 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.
  6. Albuquerque, Rui, 2007. "Optimal currency hedging," Global Finance Journal, Elsevier, vol. 18(1), pages 16-33.
  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. 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.
  10. 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.
  11. Paul Krugman, 2000. "Crises : the price of globalization?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 75-106.
  12. 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.
  13. 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.
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