Foreign Exchange Rate Exposure of Companies under Dynamic Regret

71 Pages Posted: 3 Sep 2019

See all articles by Oliver Entrop

Oliver Entrop

University of Passau

Fabian U. Fuchs

University of Passau, Chair of Finance and Banking

Date Written: August 27, 2019

Abstract

This paper analyzes optimal hedge ratios for foreign exchange (FX) rate risk of companies. Our contribution to the literature is twofold: (i) We present a theoretical two-period regret model that allows us to analyze the determinants of the optimal hedge ratio given the outcome of past hedging decisions and future expectations. The model implies that the optimal hedge ratio depends on the past hedge ratio, the past exchange rate return, the expected exchange rate return and the skewness of its distribution, its covariance to the foreign market return, as well as the company's risk and regret aversion. (ii) We test the related model-derived hypotheses on a broad sample of US non-financial companies over the period 1995 to 2015 and find strong evidence for the model's predictions. By adding a dynamic regret approach to the hedging and FX literature we shed further light on the rationale behind selective hedging.

Keywords: exchange rate exposure, regret aversion, hedging, risk aversion, derivatives

JEL Classification: F31, G15, G32, G41

Suggested Citation

Entrop, Oliver and Fuchs, Fabian Ulrich, Foreign Exchange Rate Exposure of Companies under Dynamic Regret (August 27, 2019). Available at SSRN: https://ssrn.com/abstract=3443487 or http://dx.doi.org/10.2139/ssrn.3443487

Oliver Entrop (Contact Author)

University of Passau ( email )

Innstrasse 27
Passau, 94032
Germany
+49 851 509 2460 (Phone)
+49 851 509 2462 (Fax)

Fabian Ulrich Fuchs

University of Passau, Chair of Finance and Banking ( email )

Innstrasse 27
Passau, 94032
Germany

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
39
Abstract Views
442
PlumX Metrics