Figure 3: Hedged and unhedged profits with futures and options
If there is no export flexibility, the firm’s revenue is linear in the exchange rate. This
is represented by the dashed line and its solid continuation in Figure 3. In this case,
unbiased currency futures are the preferred hedging instrument since they are also linear
in the exchange rate. As shown by Battermann et al. (2000), fairly-priced options will
not be used by an inflexible firm.
On the other hand, a fully flexible firm will entirely rely on fairly priced currency call
options. Broll and Wahl (1997) have shown that full hedging with call options eliminates
exchange rate risk. This is due to the fact that revenue is piecewise linear in the exchange
rate with a zero slope for low exchange rate realizations. It follows that a risk averse and
fully flexible firm will never use unbiased currency futures since this would increase risk
while leaving expected profits unchanged.
Restricted export flexibility allows the firm to implicitly hedge against its exchange
rate risk exposure by the sales allocation between the domestic and foreign markets.
14
More intriguing information
1. Exchange Rate Uncertainty and Trade Growth - A Comparison of Linear and Nonlinear (Forecasting) Models2. Inflation Targeting and Nonlinear Policy Rules: The Case of Asymmetric Preferences (new title: The Fed's monetary policy rule and U.S. inflation: The case of asymmetric preferences)
3. Applications of Evolutionary Economic Geography
4. Migrant Business Networks and FDI
5. Personal Experience: A Most Vicious and Limited Circle!? On the Role of Entrepreneurial Experience for Firm Survival
6. The name is absent
7. The Variable-Rate Decision for Multiple Inputs with Multiple Management Zones
8. LIMITS OF PUBLIC POLICY EDUCATION
9. Short- and long-term experience in pulmonary vein segmental ostial ablation for paroxysmal atrial fibrillation*
10. Mean Variance Optimization of Non-Linear Systems and Worst-case Analysis