AN EMPIRICAL ANALYSIS OF HEDGING WITH CURRENCY DERIVATIVES IN CHINA

Abstract

As the international standing of China has improved, which has motivated more and more firms to take part in the global market for business. This study intends to investigate the sensitivity of firms involved in foreign business activities to fluctuating exchange rates, explore the determinants of foreign exchange exposure and firms’ risk management strategies with currency derivatives, and examine the firm value effects arising from the use of foreign currency derivatives.

I initially examined the sensitivity of a firm’s stock price to exchange rate changes and found that from July 2005 to 2012, around 8% of the listed firms on the Shanghai stock exchange have significant foreign exchange exposure and 6% of the listed firms experienced a lagged effect from exchange rate movements. The foreign involvement, which indicates the level of foreign trade of the firm, is a significant factor affecting the foreign exchange exposure in the post market liberalisation period. This is the first-time the liberalisation of the Chinese stock market after 2012 has been analysed when identifying the determinants of foreign exchange exposure. As few firms usually show any significant exposure, often known as the exposure puzzle, the study finds that an increasing number of multinational firms from the Shenzhen Stock market use foreign currency derivatives to hedge from 2012 to 2017. The level of trade is one of the significant determinants of hedging in China. Meanwhile, I consider agency problems and information asymmetry as determinants of derivatives use in the estimation. Furthermore, the main findings show that firms below the leverage threshold level of debt could benefit from the use of foreign currency derivtives. Meanwhile, the diversified ownership structure, indicating lower agency costs, is positively related to the firm value.

This study contributes to the literature on hedging with currency derivatives by exploring an emerging market instead of the more usual developed countries. It first finds that the level of foreign trade can reflect the foreign exchange exposure only after the financial maket is liberalised. Moreover, it employs dynamic panel model to examine the drivers of the use of foreign currency derivatives while the majority of studies previously focused on a static model. The study is the first to estimate the valuation effects of currency derivatives based on the threshold effect arising from the level of debt.

Overall, this study aims to analyze the use of currency derivatives in China and provide policy implications for various stakeholders. As derivatives are a double edged sword, the financial aurthorities and regulators should strengthen the capital markets levels of efficiency and transparency to ensure their stability while developing the financial derivatives markets.

Date of Award	11 Oct 2021
Original language	English
Awarding Institution	University of Bath
Supervisor	Bruce Morley (Supervisor) & Paolo Zeppini (Supervisor)