Transcript Exchange rate exposure, hedging, and the use of foreign
JEM044 International finance Lenka Čepeláková Karolína Dlasková Rostislav Hrdý Alžběta Kočová
Exchange rate exposure, hedging, and the use of foreign currency derivatives
George Allayannis and Eli Ofe
Outline
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Introduction Data sample Exchange-rate exposure and currency derivatives
3.1 Estimation framework 3.2 Tests and results 3.3 Robustness tests 3.4 Robustness tests: alternative sample
The determinants of the extent of hedging
4.1 Related literature 4.2 Tests and results 4.3 The determinants of the level of foreign debt
Conclusion 26.04.2020
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Outline
1.
2.
3.
4.
5.
Introduction Data sample Exchange-rate exposure and currency derivatives
3.1 Estimation framework 3.2 Tests and results 3.3 Robustness tests 3.4 Robustness tests: alternative sample
The determinants of the extent of hedging
4.1 Related literature 4.2 Tests and results 4.3 The determinants of the level of foreign debt
Conclusion 26.04.2020
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Introduction
Main research question of the paper:
Do firms use foreign currency derivatives for hedging or for speculative purposes?
Short answer:
Firms use derivatives for hedging.
Exchange rate exposure
and the = change in the exchange rate relationship between excess return They measure exchange-rate exposure as the the firm , proxied by the firm’s stock return, sensitivity of the value of to an unanticipated change in an exchange rate .
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Introduction
They examine:
a) the effect of foreign currency derivative use on its exchange rate exposure b) the determinants of the amount of derivative use
Hypothesis:
• using foreign currency derivatives for hedging reduces a firm’s foreign exchange-rate exposure • the degree to which firms use derivatives is related to its exchange rate exposure through foreign sales and foreign trade 26.04.2020
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Introduction
• The authors estimate multivariate regression - contrasts with Hentschel and Kothari (1997) who used univariate tests • Use of continuous variable instead of dummy variable • Two-stage framework allows to examine separately what influences decision to hedge and what determines extent of hedging. This approach also allows find out relationship between firm size, R&D expenditure and using currency derivatives.
• They also examine using foreign debt for hedging purpose 26.04.2020
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Outline
1.
2.
3.
4.
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Introduction Data sample Exchange-rate exposure and currency derivatives
3.1 Estimation framework 3.2 Tests and results 3.3 Robustness tests 3.4 Robustness tests: alternative sample
The determinants of the extent of hedging
4.1 Related literature 4.2 Tests and results 4.3 The determinants of the level of foreign debt
Conclusion 26.04.2020
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Sample description
• Data on year-end notional value of forward contracts • Dollar notional value as a continuous variable • Annual reports of all S&P 500 nonfinancial firms in 1993 • The sample consists of 347 firms, foreign currency derivatives data 42.6% firms have complete 8 26.04.2020
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Sample description
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Outline
1.
2.
3.
4.
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Introduction Data sample Exchange-rate exposure and currency derivatives
3.1 Estimation framework 3.2 Tests and results 3.3 Robustness tests 3.4 Robustness tests: alternative sample
The determinants of the extent of hedging
4.1 Related literature 4.2 Tests and results 4.3 The determinants of the level of foreign debt
Conclusion 26.04.2020
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Methodology – equation 1
• • Predicting economic exposure to exchange movements = regression coefficient of the value of the firm on the exchange rate across state of nature
Equation 1
: 𝑅 𝑖𝑡 = 𝛽 0𝑖 + 𝛽 1𝑖 𝑅 𝑚𝑡 + 𝛽 2𝑖 𝐹𝑋𝐼 𝑡 Where 𝑅 𝑖𝑡 is the rate of return on the ith period t + 𝜖 𝑖𝑡 , 𝑡 = 1, … 𝑇 firm’s common stock in 𝑅 𝑚𝑡 is the rate of return on the market portfolio in period t 𝐹𝑋𝐼 𝑡 is the rate of return on a moving, trade-weighted exchange rate index, measured in US dollars per unit of foreign currencies in period t • 𝜷 𝟐𝒊 represents the exchange-rate exposure Measures the percentage change in the rate of return on a firm’s common stock against a 1% change in the exchange rate 26.04.2020
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Methodology – data used
• • • • •
Rate index used:
J.P. Morgan’s narrow, trade-weighted, nominal Measures strength of the dollar relative to a basket of 18 other OECD countries
For sensitivity:
also RX-101 index Real, much broader index , published by Federal Reserve in Dallas, 101 countries
Market movements:
CRSP monthly value-weighted market index
1993 sample
= monthly return data in 1992-94 – Daily od weekly data too noisy
Other time intervals:
1991-95, five year data 26.04.2020
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Methodology – equation 2
•
Second stage
: examining potential impact of a firm’s currency derivative use on its exchange-rate exposure • Equation 2: 1, … 𝑁 2𝑖 = 𝛼 1𝑖 + 𝛼 2𝑖 𝐹𝑆 𝑇𝑆 𝑖 + 𝛼 3𝑖 𝐹𝐶𝐷 𝑇𝐴 𝑖 + 𝜇 𝑖 , 𝑖 = Where 𝟐𝒊 is a firm’s exchange-rate exposure estimated in Model 1 𝐹𝑆 𝑇𝑆 𝑖 𝐹𝐶𝐷 i s a firm’s ration of foreign sales to total sales is a firm’s ratio of foreign currency derivatives 𝑇𝐴 𝑖 to total assets 26.04.2020
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Outline
1.
2.
3.
4.
5.
Introduction Data sample Exchange-rate exposure and currency derivatives
3.1 Estimation framework 3.2 Tests and results 3.3 Robustness tests 3.4 Robustness tests: alternative sample
The determinants of the extent of hedging
4.1 Related literature 4.2 Tests and results 4.3 The determinants of the level of foreign debt
Conclusion 26.04.2020
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Tested hypotheses
•
H1: Ratio of foreign sales to total sales has positive coefficient
For a given exposure, an increase in revenues from foreign operations should increase exposure Exporter is hurt by appreciation – positive exposure Importer benefits an appreciation – negative exposure •
H2.1: Hedging purpose –
absolute value of derivatives used negatively related to the absolute values of exchange-rate exposures Positive exposure: decrease of the exposure Negative exposure: increase of the exposure •
H2.2: Speculating purpose
– values positive relation between absolute 26.04.2020
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Results
•
Regression 1
– all exposures considered Strong positive effect in the ratio foreign sales to total sales = confirming H1 •
Regression 2
– using absolute values of exposures Negative, significant association = confirming H2.1
• As previous model suffer from omitted variable problem, both factors positively correlated •
Regression 3
– choosing positive exposures only Confirming both H1 and H2.1
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The regressions
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Outline
1.
2.
3.
4.
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Introduction Data sample Exchange-rate exposure and currency derivatives
3.1 Estimation framework 3.2 Tests and results 3.3 Robustness tests 3.4 Robustness tests: alternative sample
The determinants of the extent of hedging
4.1 Related literature 4.2 Tests and results 4.3 The determinants of the level of foreign debt
Conclusion 26.04.2020
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Robustness tests (1)
• • •
1. testing different time period:
five-year time interval instead of three-year time interval Similar results, both confirmed
2. alternative exchange-rate index
Broader index: better capturing exposure Narrow, nominal index: better capturing impact of derivative use Choice does not affect results
3. sample of firms who disclosed currency derivative use in 1992
Data from 1991/93 used H2.1 confirmed, H.1 result not statistically significant 26.04.2020
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Robustness tests (2)
• • •
Different estimation methods 4. Weighted least squares for equation 2
Weighting factor is the inverse of the standard error of the exposure coefficients estimated by equation 1 – assign more weight on more precise estimates Results unchanged
5. Probit estimation
Dependent variable – binary variable (1 if a firm’s exposure is statistically significant at the 10% significance level: 22% of sample, zero otherwise) Results again unchanged 26.04.2020
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Regression results from robustness tests
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Outline
1.
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Introduction Data sample Exchange-rate exposure and currency derivatives
3.1 Estimation framework 3.2 Tests and results 3.3 Robustness tests 3.4 Robustness tests: alternative sample
The determinants of the extent of hedging
4.1 Related literature 4.2 Tests and results 4.3 The determinants of the level of foreign debt
Conclusion 26.04.2020
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Robustness tests: alternative samples
•
Alternative sample
– Use of larger cross-section of firms – Allows to examine the robustness of the results in later years (1994 and 1995) – The inclusion of smaller firms , use of individual Exchange rates •
Data
– Data on the use of currency derivatives for all US manufacturing firms which have assets above 100 million in 1994 and 1995 – There is a total of 916 firms that meet the criteria • Returns for the three-year period surrounding the particular year of interest are used 26.04.2020
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Hypothesis
• • • •
H1:
The absolute value of currency derivatives used is negatively related to the absolute value of currency exposure.
H2:
The exposure is negatively related to the use of currency derivatives using all firms with positive exposures.
H3:
Small firms use derivatives as effectively as large firms.
H4:
The robustness of the results to the use of an alternative European index and two individual exchange rates.
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FX exposure and the use of derivatives
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Robustness Tests: Results
•
Robust
and size .
to sample, year, estimation technique, individual currency •
Support
the hypothesis that firms ’ reduces their exchange-rate exposure .
use of currency derivatives •
Strongly confirm
hypothesis that firms use foreign currency derivatives to hedge to speculate against exchange-rate movements, in foreign exchange markets.
rather than 26.04.2020
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Outline
1.
2.
3.
4.
5.
Introduction Data sample Exchange-rate exposure and currency derivatives
3.1 Estimation framework 3.2 Tests and results 3.3 Robustness tests 3.4 Robustness tests: alternative sample
The determinants of the extent of hedging
4.1 Related literature 4.2 Tests and results 4.3 The determinants of the level of foreign debt
Conclusion 26.04.2020
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The determinants of the extent of hedging -Related Literature
There are several theories of optimal hedging:
• Corporate hedging arises as a (Stulz, 1984) result of managerial risk aversion • The structure distress of the tax code or the transaction costs of financial could prompt firms to undertake hedging activities. (Smith and Stulz, 1985) .
• Corporate hedging is information on the optimal when managers have private firm’s expected payoff despite shareholders’ ability to hedge by themselves. (DeMarzo and Duffie, 1995).
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Related Literature
• Literature focused on the type of hedging or currency), recognizing that (commodity, interest rate, different factors can be important for each type of hedging.
• Mian (1996) investigates all three types of hedging activities – finds mixed evidence for theories of managerial risk aversion and taxes – evidence that exhibit strongly supports economies of scale the hypothesis that hedging activities (i.e., that larger firms hedge more).
•
The first study
that has looked for the factors that are associated with the extent of hedging.
• In this paper, this question is examined currency hedging and for a in the context of foreign large cross-section of industries.
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Outline
1.
2.
3.
4.
5.
Introduction Data sample Exchange-rate exposure and currency derivatives
3.1 Estimation framework 3.2 Tests and results 3.3 Robustness tests 3.4 Robustness tests: alternative sample
The determinants of the extent of hedging
4.1 Related literature 4.2 Tests and results 4.3 The determinants of the level of foreign debt
Conclusion 26.04.2020
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The determinants of the extent of hedging - Models
• One step decision – Tobit method • Two steps decision – Two-stage process (Cragg, 1971) 1) Binominal probit for all firms (Hedge/not hedge) 2) Truncated regression for hedging firms only - fits the data better • •
Depended variable:
amount of derivative
Independed variables:
firm size, proxy for R&D expenditures and controls for exposure (foreign income and trade) • • Year-end data on foreign debt for 1993
H1
: Firms use hedge both foreign debt and foreign currency derivatives their exchangerate exposure to 26.04.2020
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Tests and results – use and level of FX derivatives
• Size of the firm positively related to the decision to hedge • Frirms with higher R&D expenditures benefit more from the use of derivatives • Both exposure factors (foreign sales and foreign trade) significantly and positively related to a firm’s decision to hedge • The hypothesis from previous section: Firms use currency derivatives to hedge their exchange-rate exposure, rather than to speculate in the foreign exchange markets confimed again.
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Outline
1.
2.
3.
4.
5.
Introduction Data sample Exchange-rate exposure and currency derivatives
3.1 Estimation framework 3.2 Tests and results 3.3 Robustness tests 3.4 Robustness tests: alternative sample
The determinants of the extent of hedging
4.1 Related literature 4.2 Tests and results 4.3 The determinants of the level of foreign debt
Conclusion 26.04.2020
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The determinants of the level of foreign debt
•
Foreign debt
=> creates a stream of cash outflows in a foreign currency (good for firms with revenues in foreign currencies) - High fixed start-up costs •
Ratio of foreign sales to total sales
positively related with decision to use foreign debt firm’s • •
Size
of the firm positively
Smaller
firms issue related with the use of foreign debt larger amounts of foreign debt • No evidence that
exporters
are more likely to issue foreign debt • This result is generally consistent with previous hypothesis 26.04.2020
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Currency derivatives or foreign debt?
•
Logit model
• dependent variable:
1
if firm uses only foreign currency derivatives
0
if the firm uses only foreign debt • •
No significant evidence
that multinationals prefer to use foreign currency derivatives or debt to hedge % of firms
Significant evidence
that exporters prefer the use of foreign currency derivatives over the use of foreign currency debt • H1 confirmed 50 40 30 20 10 0 Currency derivatives Foreign debt 26.04.2020
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Outline
1.
2.
3.
4.
5.
Introduction Data sample Exchange-rate exposure and currency derivatives
3.1 Estimation framework 3.2 Tests and results 3.3 Robustness tests 3.4 Robustness tests: alternative sample
The determinants of the extent of hedging
4.1 Related literature 4.2 Tests and results 4.3 The determinants of the level of foreign debt
Conclusion 26.04.2020
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Summary
• Data sample • Methodology • Results • Robustness tests • The determinants of the extent of hedging (foreign debt) 37 26.04.2020
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Conclusion
• • • • • • • • • The authors showed:
Strong negative association
between foreign currency derivative use and firm exchange-rate exposure=> firms use derivatives as a hedge rather than to speculate
Robustness of the results
to alternative time intervals, exchange-rate indices, the use of a larger, alternative sample and to the use of individual exchange rates.
Firm’s exposure through foreign sales and foreign trade is a very important factor that both prompts corporations to hedge and guides their decision on how much to hedge.
Firms also use foreign debt to protect themselves from exchange-rate movements Firm’s exposure through foreign sales is an important determinant of its decision to use foreign debt and on its decision on the level of foreign debt Firms use currency derivatives
as a hedge
2x more often than foreign debt Important implications for managers and financial regulators. A firm’s exposure to exchange-rate movements is mitigated foreign currency derivatives through the use of An intervention in the derivatives markets may not be warranted, and provides an explanation for the lack of significant exposure documented in past studies 26.04.2020
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Any questions?
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Thank you for your attention.
Lenka Čepeláková Karolína Dlasková Rostislav Hrdý Alžběta Kočová 26.04.2020
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