Modelling information and hedging: the exporting firm

The paper examines the economic role of modelling information on the decision problem of an exporting firm under exchange rate risk and hedging. Information is described in terms of market transparency, i.e., a publicly observable signal conveys more information about the random foreign exchange rate. We analyze the interaction between market transparency and the ex ante expected utility of the exporting firm. It is shown that more transparency on the foreign exchange market may result in higher or lower export production. --Information,transparency,exchange rate risk,hedging,trade

A Note on Hedging a Loan Portfolio

In the framework of the industrial economics approach to banking we extend the analysis of hedging against default on loans to the case of two types of credit risk. Standard results on the optimal hedge volume and the hedging effectivity from the single-risk case are shown to carry over to the portfolio case in a non-trivial but intuitive way.banking, credit risk, loan portfolio, credit derivative, hedging effectivity

Transparency in the foreign exchange market and the volume of international trade

In this paper we study the impact of more transparency in the foreign exchange market on the ex ante expected volume of international trade. Transparency is measured by the informational content of publicly observed signals correlated to the random exchange rate. We find that more transparency may increase or decrease the volume of international trade. In particular, the impact of more transparency depends the curvature of the marginal cost function of the firms. Furthermore, ex ante expected profits of the firms are higher when the foreign exchange market is more transparent. --exchange rate risk,transparency,export production,futures markets

The Competitive Firm Under Price Uncertainty: The Role of Information and Hedging

We study the impact of transparency in a commodity market on the decision problem of a competitive firm under price uncertainty and hedging opportunities. Market transparency is modeled by means of the informational content of publicly observable signals which are correlated with the random price. We find that the impact of more transparency on labor employment and production depends on the firm's technology. Inparticular, more transparency may result in lower average output even though on average more labor has been used in the production process. We also analyze the link between market transparency and the welfare of the firm. --Transparency,information system,price uncertainty,hedging,competitive firm

German Foreign Direct Investment and Wages

Over the last decade, German multinationals created about two million jobs abroad with increasing foreign direct investment (FDI). While there are many reasons for firms to go multinational and probably just as many for Germany's high unemployment, this paper aims to investigate the relationship between domestic labour costs and foreign direct investment. We apply a theoretical model for an econometric analysis examining the determinants of FDI using panel data of German firms' foreign capital stocks in 22 countries between 1994 and 2003. Estimating elasticities, we find that while domestic wages do not significantly influence total FDI by German firms, they positively affect the FDI stock in countries where cheap labour is abundant. Thus, although Germany's high labour costs are not the sole driver of foreign direct investment, they may accelerate the outsourcing of German jobs. --Foreign direct investment,wages,trade,German multinational firms

Transparency in the Interbank Market and the Volume of Bank Intermediated Loans

In this paper we study the impact of more transparency in the interbank market on the volume of bank intermediated loans and on the profitability of the banking business. Transparency is modeled by means of the informational content of publicly observable signals correlated to the random interbank interest rate. We find that more transparency may increase or decrease the volume of bank loans. In particular, the impact of more transparency on the volume of loans depends on the curvature of the marginal cost function of the banking firm. Furthermore, we find that ex ante expected profits of the bank are higher when the interbank market is more transparent. --banking firm,interbank market,interest rate risk,hedging,transparency

The effect of exchange rate risk on US foreign direct investment: an empirical analysis

This paper empirically analyzes the impact of exchange rate uncertainty, exchange rate movements and expectations on foreign direct investment (FDI). Two competing specifications of exchange rate volatility are examined. The investigation is based on a cross-section time-series data set of U.S. outward FDI by industries to six major partner countries for the period 1984-2004. Using the standard deviation of the real exchange rate as a measure of risk it is found that exchange rate uncertainty has a discouraging effect on FDI flows across all industries. This is contrasted when applying an alternative risk specification defined as the unexplained part of real exchange rate volatility. Now, results show a clear distinction between non-manufacturing and manufacturing industries. U.S. FDI outflows in nonmanufacturing industries exhibit a positive correlation with increased exchange risk, whereas this relationship is negative for manufacturing industries in the underlying sample. A real appreciation of host-country currency was associated with higher FDI flows, while expectations about an appreciation showed a negative result. --Foreign direct investment,real exchange rate risk,volatility

Liquidity constrained exporters: Trade and futures hedging

We present a model of risk averse exporting firm subject to liquidity constraints. The firm enters an unbiased futuresmarket to hedge exchange rate risk and may not be able to satisfy high margin calls. Then the firm is forced toprematurely liquidate the futures position. We show that preferences and expectations become important for optimumexport and hedging decisions, i.e. separation theorem and full hedge theorem are violated. Furthermore, internationaltrade is affected, for only firms that have sufficient financial resources fully exploid gains from trade. --liquidity constraint,trade,futures,hedging

Optimal hedge ratio and elasticity of risk aversion

We apply the mean-standard deviation paradigm to examine a widely used model of the hedging literature. As the hedging model satisfies a scale and location condition the mean-standard deviation technique provides more intuition for the revision of the firm's optimum risk taking when price volatility changes. By introducing risk aversion elasticity we describe the interaction of price risk and optimum hedge. We show that with unit risk aversion elasticity optimum hedge ratio is invariant to changes in price volatilities.elasticity of risk aversion

The firm under uncertainty: capital structure and background risk

This paper examines the interplay between the real and financial decisions of the competitive firm under output price uncertainty. The firm faces additional sources of uncertainty that are aggregated into a background risk. We show that the firm always chooses its optimal debt-equity ratio to minimize the weighted average cost of capital, irrespective of the risk attitude of the firm and the incidence of the underlying uncertainty. We further show that the firm's optimal input mix depends on its optimal debt-equity ratio, thereby rendering the interdependence of the real and financial decisions of the firm. When the background risk is either additive or multiplicative, we provide reasonable restrictions on the firm's preferences so as to ensure that the firm's optimal output is adversely affected upon the introduction of the background risk. --Background risk,Capital structure,Price uncertainty