Operational Hedging as an Alternative to Financial Hedging in the Absence of Sophisticated Financial Markets

In this paper it is demonstrated that the operational hedging techniques of risk sharing and currency collars can be as effective as forward hedging in reducing transaction exposure to foreign exchange risk. For this purpose we use historical data on the exchange rates of the Kuwaiti dinar against five major currencies. It is shown that the effectiveness of these hedging techniques depends on some parameters, specifically the upper and lower values of the exchange rate in the case of a currency collar and the range within which foreign currency cash flows are converted at the market rate in the case of a risk sharing agreement. It is concluded that these operational hedging techniques can be resorted to as an alternative to financial hedging in the absence of sophisticated financial markets.