FX Hedging and Creditor Rights

18 Pages Posted: 6 Apr 2018

See all articles by Madhusudan S. Mohanty

Madhusudan S. Mohanty

Bank for International Settlements (BIS) - Monetary and Economic Department

Suresh M. Sundaresan

Columbia Business School - Finance and Economics

Date Written: March 2018

Abstract

The paper draws on Mohanty and Sundaresan (2018) to explore the effects of bankruptcy laws on the ex ante incentive for firms to hedge FX exposures. We use a simple model in which the bankruptcy code may result in deadweight losses, and may allow equity holders a share of residual value of the firm’s assets in the bankruptcy proceedings. The paper predicts that, while value-maximising firms promise to hedge a higher fraction of the value of their FX exposure when the debt is issued, they may renege subsequently and take on some FX exposures at the expense of foreign creditors. To preclude this, strong and enforceable loan/bond covenants must be in place. Furthermore, the model predicts that FX exposure affects credit spreads, and that thin FX hedging markets lead to greater FX exposure, and a higher probability of default. The paper tests these theoretical predictions and shows that unhedged corporate FX exposures at the country level are indeed negatively associated with the strength of creditor rights and the depth of hedging markets. Using loan-specific data from the Reserve Bank of India, and exploiting recent changes in the bankruptcy law, the paper uncovers a clear connection between the creditor rights and the hedging behaviour of non-financial firms.

Full Publication: The Price, Real and Financial Effects of Exchange Rates

Keywords: foreign currency exposure; corporate hedging; creditor rights

JEL Classification: F31, G13, G28

Suggested Citation

Mohanty, Madhusudan S. and Sundaresan, Suresh M., FX Hedging and Creditor Rights (March 2018). BIS Paper No. 96b. Available at SSRN: https://ssrn.com/abstract=3154026

Madhusudan S. Mohanty (Contact Author)

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

Suresh M. Sundaresan

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States
212-854-4423 (Phone)
212-316-9180 (Fax)

HOME PAGE: http://www0.gsb.columbia.edu/faculty/ssundaresan/

Register to save articles to
your library

Register

Paper statistics

Downloads
34
Abstract Views
175
PlumX Metrics