Essays on Foreign Currency Risk Management

This dissertation studies on-balance-sheet and off-balance-sheet foreign currency risk management of corporate firms and commercial banks. It is comprised of two essays.The first essay investigates what determines firms foreign currency spot net asset positions, derivatives hedging and synthetic hedging positions. We build a model that anticipates a firms market timing in currency markets and credit markets according to the exchange-rate return and interest rate differential. Using a unique set of data containing complete foreign currency spot and derivatives positions of Korean exporting firms, we empirically find that currency position-squaring firms have significantly higher firm value. We also find evidence that these firms time the currency market when they manage their currency cash position. Meanwhile, firms time the credit market when they determine the use of foreign currency debts. Strikingly, firms still time the market even when they conduct derivatives hedging and synthetic hedging. Our findings are consistent with the market timing theory of capital structure.The second essay examines what determines banks exposure to foreign currency risks, their management of these risks, and the relationship to the probability of bank failures. Using a unique data set of Korean banks with detailed information on their foreign currency risk exposures and hedging positions, we find that banks foreign currency position mismatches, maturity mismatches, and debt roll-over risks are significantly attributed to their dollar carry lending strategy, which is stimulated by market timing of corporate firms, short-maturity dollar borrowings, real estate market booms, and dollar interest rate tightening. We also find that banks foreign currency exposures significantly increase their financial distress likelihood through dollar carry lending activities. Finally we show that, overall, banks that better match their foreign currency positions and maturities are rewarded with lower probabilities of financial distress.