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Financial and operational hedging of exposure to foreign exchange risk: a GCC perspective

By A Bash

Abstract

This thesis is concerned with the management of foreign-exchange risk. We take the perspective of a domestic firm that is exposed to foreign currencies (such as the GBP, CHF, and JPY) operating in a member country of the Gulf Co-operation Council (GCC). Three important questions are involved in hedging: (i) to hedge or not; (ii) the choice of the hedging instrument; and (iii) measurement of the hedge ratio. Our results show that there is no difference in performance and risk under these three hedging strategies (always to hedge, to hedge or not to hedge, and always not to hedge) for all of the GCC currencies against foreign currencies. Our examination of the effectiveness of three financial hedging techniques—forward hedging, money-market hedging and cross-currency hedging—shows that it makes no difference whether we use forward hedging or money-market hedging (for all of the GCC currencies against foreign currencies). However, in relation to cross-currency hedging, the results are mixed. We find that the effectiveness of cross-currency hedging depends on the correlation between the exchange rates of the base currency against the exposure currency, and the currency used as the hedging instrument. In examining the effectiveness of financial hedging (such as forward hedging) versus operational hedging, (such as risk-sharing arrangements, currency collars, and hybrid arrangements) we find that forward hedging is more effective than either risk-sharing arrangements or hybrid arrangements. However, when compared with currency collars, the results are mixed. Finally, we find that the use of different econometric models to estimate the hedge ratio fails either to add value or improve the effectiveness of the hedge. This implies that there is no need for a sophisticated econometric model to estimate the hedge ratio, because what matters is correlation

Topics: Fields of Research, Financial hedging, Operational hedging, Gulf Co-operation Council, Hedging effectiveness, Hedge ratio, Foreign-exchange risk
Publisher: RMIT University
Year: 2015
OAI identifier: oai:researchbank.rmit.edu.au:rmit:161626

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