Title: Optimal Export and Hedging Decisions When Forward Markets Are Incomplete
Reference Number: 1151
Publication Date: February 2006
JEL Classifcation: D81; F23; F31
Author(s):

Kit Pong Wong
The University of Hong Kong

Abstract:

This paper examines the behavior of the competitive firm that exports to two foreign countries under multiple sources of exchange rate uncertainty. There is a forward market between the home currency and one foreign country's currency, but there are no hedging instruments directly related to the other foreign country's currency. We show that the separation theorem holds when the firm optimally exports to the foreign country with the currency forward market. The full-hedging theorem holds when the firm either exports exclusively to the foreign country with the currency forward market or when the relevant spot exchange rates are independent. In the case that the relevant spot exchange rates are positively (negatively) correlated in the sense of regression dependence, the firm optimally opts for a short (long) forward position for cross-hedging purposes.

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Key words: Exports; Cross-hedging; Regression dependence

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Last modified: 03/28/2006