Richard C. Marston

1998 Wharton Survey of Financial Risk Management by US Non-Financial Firms

This is the third in a series of surveys on financial risk management practice and derivatives use by non-financial corporations in the United States undertaken by the Wharton School. This 1998 survey, written in partnership again with CIBC World Markets, extends the previous two surveys by asking new questions about certain aspects of derivative use and risk management practice. This report compares responses across the various surveys and notes changes in responses over time. A tabulation of the responses to all questions is included in the appendix.

1995 Wharton Survey of Derivatives Usage by US Non-Financial Firms

In November, 1994, the Weiss Center for International Financial Research of the Wharton School undertook its first survey of derivatives and risk management practice by non-financial corporations in the United States. This 1995 survey, sponsored by CIBC Wood Gundy, is more detailed than the 1994 survey, with a broader range of questions about valuation and risk management and with more specific questions about the use of derivatives. One of the primary objectives of the survey is the development of a database on risk management practices suitable for academic research.

Stabilization Policies in Open Economies

Publisher Summary This chapter discusses that the modern open economy is not the one found in most macroeconomic textbooks, an economy that occasionally imports Bordeaux wine but which produces most of what it consumes at prices determined domestically. It is rather an economy integrated with those abroad through commodity and financial linkages that limit the scope for national stabilization policy. The progressive modifications are classified into three categories: capital mobility; wage and price flexibility; and rational expectations and the natural rate hypothesis. The chapter examines standard propositions about policy using rational expectations and a stochastic supply function. The same model is used to re-examine the choice between exchange rate regimes and the insulating properties of flexible rates. The chapter focuses on a single national economy. This economy is assumed to produce its own good and to issue its own interest-bearing bond. In limiting cases commodity arbitrage pegs the price of the good at purchasing power parity and financial arbitrage pegs the interest rate at interest parity.

Wages, Relative Prices and the Choice between Fixed and Flexible Exchange Rates

This paper reexamines the choice between fixed and flexible rates to take into account wage indexation and flexible prices. The model employed is of a small open economy faced by monetary and aggregate demand disturbances originating at ham and abroad. Aggregate supply behavior in this &el varies depending upon whether wages are set in one-period labor contracts or are indexed to current changes in the general price level, Two central conclusions emerge from the analysis. First, for all disturbances the difference in output variation between fixed and flexible rates is dependent upon the degree of wage indexation, being proportional to one minus the degree of wage indexation in the domestic economy. Thus the more highly indexed the economy, the less difference the choice of exchange rate regime makes to output variation, Secondly, the effect of foreign disturbances on the domestic economy depends as much on foreign wage and price behavior as domestic. If the rest of the world is fully indexed, flexible rates insulate the domestic country completely from foreign monetary disturbances, If the rest of the world is more highly indexed than the domestic country, then for high price elasticities at least, a flexible rate dampens the output variation associated with foreign demand disturbances.

Interest arbitrage in the Euro-currency markets

Abstract This study investigates how interest rates in the non-dollar Euro-currency markets are determined. Each of these Euro-currency rates is linked to the Euro-dollar rate through arbitrage operations undertaken by banks. Evidence from regressions of the Euro-currency rates on the Euro-dollar rate and the corresponding forward premium confirms that each non-dollar rate adheres closely to interest parity. Arbitrage results in unifying the Euro-currency markets so that supply and demand pressures in any individual market are spread throughout other Euro-currency markets. Because of the overwhelming size of the Euro-dollar market, conditions in this market tend to dominate conditions in the remaining Euro-currency markets.

Sterilization policy: The trade-off between monetary autonomy and control over foreign exchange reserves

This paper investigates the trade-off between monetary autonomy and control over forel in exchange reserves within the context of a structural model of the monetary sector. This structural model integrates the analysis of international capital movements with the determination of the supply of money and the domestic interest rate. Particular emphasis is placed on captial flow offsets to monetary policy and sterilization behavior by the monetary authorities. An expression is derived which explicitly describes the trade of between the control of foreign exchange resetires and the control of bank reserves. Empirical estimaties for this trade-off are presented for Germany.

Tests of three parity conditions: Distinguishing risk premia and systematic forecast errors

Two explanations are given for why nominal or real returns differ across currencies: foreign exchange risk premia and systematic (rational) forecast errors. This study reexamines three parity conditions in international finance, uncovered interest parity, purchasing power parity, and real interest parity, to determine the relative importance of these two factors. The study develops joint tests of the three parity conditions by relating nominal and real interest differentials and inflation differentials to the same set of variables currently known to investors. The study tests parameter restrictions based on knowing that risk premiums only affect nominal and real interest differentials, but not inflation differentials, while systematic errors in forecasting exchange rates only affect nominal interest differentials and inflation differentials, but not real interest differentials.

A Simple Model of Foreign Exchange Exposure

Foreign exchange exposure refers to the sensitivity of a firms cash flows to changes in exchange rates. This study develops a model of foreign exchange exposure dependent on only three variables, the percentage of the firms revenues and expenses denominated in foreign currency and its profit rate. Exposure is estimated for a sample of 103 U.S. firms that participated in the 1998 Wharton/CIBC Survey of Risk Management by U.S. Non-Financial Firms. The study finds that foreign exchange exposure is quite low for a majority of firms in the sample because these firms have been able to match their foreign currency revenues and costs leaving them with little net exposure. Such operational hedges may help to explain why previous studies have found low or negligible levels of exposure when they studied the sensitivity of share prices to foreign exchange rates.

Systematic movements in real exchange rates in the G-5: Evidence on the integration of internal and external markets

Many recent studies have documented the random behavior of real exchange rates. This paper shows that real exchange rates defined for different sectors of an economy move closely together with one another even though each of the sectoral real exchange rates taken alone has a large random component. The sectoral real exchange rates are tied together by internal price links due to factor mobility within each national economy. Any differences between real exchange rates which develop, moreover, can be explained almost entirely by productivity differentials, at least in the long run. This paper contrasts the strong ties which bind together prices from different sectors internally with ties that bind the prices of goods from the same sector internationally. Prices are shown to be much more highly correlated internally than externally because flexible exchange rates disrupt normal pricing relationships between goods from different countries.

Exchange rate exposure: A simple model

This study develops a model of foreign exchange exposure dependent on only three variables, the percentage of the firms revenues and expenses denominated in foreign currency and its profit rate. The model demonstrates that foreign exchange exposure elasticities should be largest for pure exporting and importing firms, especially those with low profit margins. Exposure elasticities should be smaller for multinational firms that match their foreign currency revenues and costs. Such operational hedges may help to explain why previous studies have found low or negligible levels of exposure when they studied the sensitivity of share prices to foreign exchange rates.