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Restricted Export Flexibility and Risk Management with Options and Futures

By Axel F. A. Adam-Müller and Kit Pong Wong

Abstract

This paper examines the production, export and risk management decisions of a risk-averse competitive firm under exchange rate risk. The firm is export flexible in allocating its output to either the domestic market or a foreign market after observing the exchange rate. Export flexibility is restricted by certain minimum sales requirements that are due to long-term considerations. Currency options are sufficient to derive a separation result under restricted export flexibility. Under fairly priced currency futures and options, full hedging with both instruments is optimal. Introducing fairly-priced currency options stimulates production provided that the currency futures market is unbiased.restricted export flexibility, risk management, currency futures, currency options

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