Exchange Rate Risk Exposure, Export Elasticity and Hedging

Under the trade-intensive economic environment, one of the most appropriate means among alternatives in order to preserve corporate profitability from the foreign exchange rate risk is through the hedging against the exchange rate fluctuation. Working(1962) argued that when the prices are expected to drop, a selective hedging technology has been used to avoid losses in corporate profit. Dumas(1984) defined the exchange rate risk exposure as an unexpected changes on cash flow or corporate value. Leading by the Jorion (1990), many works that study the effect of exchange rate risk on the corporate cash flow were followed(Garner and Shapiro(1984), Oxelheim and Wihlborg(1987 & 1995), Brown(2001), Alder and Dumas(1984), Bartov and Bodnar(1994)). Stulz(1996) argued that a firm with comparative advantage in the market uses hedging selectively to minimize the downside risks based on the outlook of the market.Brookes et al.(2000) argued that New Zealand export companies use selective hedging technique when they recognize the characteristics of the exchange rate which tends to return to the average rate. Many of the New Zealand export companies use short-term hedging skill and practice selective hedging technique based on the exchange rate level that compared with the historical average rate. Glaum(2002) insisted that most of the German companies have hedging position when there is an anticipated currency loss and maintain an open position when anticipated a currency gain. He also found the selective hedging behavior and firm size have a significant positive effects. Brown et al.(2006) analyzed the hedging pattern of 4 gold mine firms. They increase hedging level as gold price rises. This strategy requires that gold price should go back to an average level quickly in order to achieve a windfall profits.Dekle and Ryoo(2007) calculated the export elasticity considering the exchange rate risk by using the Japanese corporate data classified into 14 industries. They reported somewhat higher figures than previous studies’ results. This result is because the positive effect of easing liquidity constraints on exports is very large when the exchange rate rises. Even though the positive impact of liquidity buffering effect is negligible or does not occur, the negative effect can be offset through hedging. While the corporate sectors in which currency depreciation eases the liquidity constraints use hedging less, sectors in which the liquidity constraints is strengthened when exchange rate rises hedge more to block the impact of exchange rate risk on cash flow