Mitigating Systemic Spillovers from Currency Hedging

Kyuil Chung (), Hail Park () and Hyun Song Shin
Additional contact information
Kyuil Chung: International Economic Studies Team, Economic Research Institute, The Bank of Korea
Hail Park: Research Planning & Coordination Team, Economic Research Institute, The Bank of Korea

No 2012-13, Working Papers from Economic Research Institute, Bank of Korea

Abstract: Korea has been a forerunner in incorporating macroprudential policies to mitigate the vulnerabilities from currency crises that can turn into a more generalized liquidity crisis. This paper examines longer-term design issues for a more resilient and stable financial system that can complement the existing macroprudential measures. In the period before the Lehman crisis of 2008, rapid growth of short-term foreign currency denominated debt in Korea was the result of banks receiving forward dollar sales by exporters and asset managers, and then hedging the long dollar position by borrowing short in dollars. Our paper examines the rationale and mechanics of a new public financial institution, provisionally called the Exchange Stabilization Corporation (ESC) whose main role is to allow Korean exporters to hedge their currency exposure without generating currency or maturity mismatch in the Korean financial system as a whole. Three features of the ESC enable such a role: (1) it is fully equity-financed, rather than debt financed like a bank (2) its gains and losses are evaluated in US dollars, and (3) it holds a portfolio of both US dollar-denominated and Korean won-denominated assets. The ESC maintains a fully hedged position by switching between assets in different currencies while balance sheet size is fixed. This is in contrast to banks, who hedge their currency exposure by expanding the balance sheet by taking on more short-term dollar denominated debt. This paper is intended as a contribution to discussions about policies toward longer-term financial resilience, rather than about short-term crisis management policies in the light of current financial developments. More detailed research and study on feasibility of the ESC would be needed before it can be put in place.

Keywords: Currency Hedging; Banking Stability; Exchange Rate Overshooting (search for similar items in EconPapers)
JEL-codes: F31 F33 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2012-11-27
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Citations: View citations in EconPapers (5)

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http://papers.bok.or.kr/RePEc_attach/wpaper/english/wp-2012-13.pdf Working Paper, 2012 (application/pdf)

Related works:
Chapter: Mitigating Systemic Spillovers from Currency Hedging (2014)
Journal Article: Mitigating Systemic Spillovers from Currency Hedging (2012)
Journal Article: Mitigating Systemic Spillovers from Currency Hedging (2012)
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