Hedging Transaction Exposure to Foreign Exchange Risk by Using Risk Sharing Arrangements and Currency Collars
Hedging Transaction Exposure to Foreign Exchange Risk by Using Risk Sharing Arrangements and Currency Collars

Summary/Abstract: A hybrid operational hedging technique is proposed to shift some of the foreign exchange risk from the importer to the exporter when the currency of the exporter is the currency of invoicing. This technique requires the conversion of the cash flows at a range of exchange rates calculated as some weighted average of the rates used under the risk-shifting techniques of risk sharing arrangements and currency collars. The problem of choosing the value of the parameter that determines how much of the risk is to be shifted to the exporter can be resolved by fine tuning the weights in such a way as to eliminate the sensitivity of the cash flows to the value of this parameter. The theoretical results are demonstrated with the use of monthly data on the exchange rate between the British pound and the U.S. dollar over the period January 1993-October 2006.

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