Modelling Foreign Exchange Rate Transaction Exposure of UK Insurance Companies: A Cash Flow-Based Methodology
Journal of Economic and Administrative Science,32(2),120-136.
17 Pages Posted: 28 Mar 2017
Date Written: May 6, 2015
Purpose: We use a sample of 59 UK insurance companies to study the sensitivity of foreign exchange exposure, to the cash flow estimation method. This approach allows a decomposition of exposure into short- and long-term components. By revealing the nature of their cash flow exposures, companies can evaluate the effectiveness of their hedging programs and focus their hedging efforts according to the nature of their exposures.
Design/methodology/approach: Martin and Mauer (2003, 2005) three-stage model is used to estimate foreign exchange rate transaction exposure for the sample of 65 UK insurance companies over the period 2004 to 2013. However, this paper has one important innovation to this method. Instead of the model used in previous papers the paper uses a model from the actuarial field that was proposed by Blum et al. (2001) for modelling foreign exchange rates with their relevant constituents (inflation and interest rate).
Findings: the evidence shows that the currency transaction exposure for non-life insurers is greater than those of life insurers. Moreover, we find that large insurers exhibit lower frequencies of foreign exchange transaction exposure than small insurers.
Keywords: Modelling Foreign Exchange Rate Exposure, UK insurance companies, Currency risk Management
JEL Classification: G22; F31
Suggested Citation: Suggested Citation