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Trade and cross hedging exchange rate risk

Udo Broll () and Kit Wong

International Economics and Economic Policy, 2015, vol. 12, issue 4, 509-520

Abstract: This paper examines the behavior of a competitive exporting firm that exports to two foreign countries under multiple sources of exchange rate uncertainty. The firm has to cross hedge its exchange rate risk exposure because there is only a forward market between the domestic currency and one foreign country’s currency. When the firm optimally exports to both foreign countries, we show that the firm’s production decision is independent of the firm’s risk attitude and of the underlying exchange rate uncertainty. We show further that the firm’s optimal forward position is depending on whether the two random exchange rates are correlated in the sense of expectation dependence. Our results refine the literature on cross-hedging by introducing the expectation dependence structure. The existing of risk-sharing institutions, such as forward markets, significantly modify the impact of uncertainty on international trade in the economy. Copyright Springer-Verlag Berlin Heidelberg 2015

Keywords: Correlated exchange rates; Cross hedging; International trade; Expectation dependence; Public policies; D21; D24; D81; F31 (search for similar items in EconPapers)
Date: 2015
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DOI: 10.1007/s10368-014-0291-x

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