Essays on exchange rate volatility and foreign exchange risk

Abstract

Since the Bretton Woods system collapsed in 1970s, converting exchange rate system from fixed to flexible has been the worldwide trend. The Korean history of FX system has been rapidly changed since late 1990s. Korea faced FX crisis late 1997, which caused a magnificent renovation in the FX system of Korea. Korea adopted the complete floating exchange rate system at the urging of IMF. Since then, the exchange rate has flexibly fluctuated depending on the demand and supply in market, and FX risk was activated in stock market and international trade. This thesis is organized into three separate essays, but they all investigate two related issues, the exchange rate volatility and foreign exchange risk. First, we report the role of currency depreciation on recovery from the global financial crisis 2007~2009. Overall, currency-depreciated countries outperformed in GDP growth, stock market return and export growth. Our study is consistent with the past empirical researches about beggar-thy-neighbor policy during the Great Depression. The currency depreciation helped escaping from economic recession during the Great Depression, and so did it during the current global financial crisis. Second, we review the firms’ FX risk exposure. We find that large firms are more likely to be exposed to FX risk than small firms, and FX risk management is more effective for large firms. It indicates that large firms would like to manage FX risk rather than bear the risk, not only because the cost of management is relatively low, but because there are differences in the effectiveness of controlling FX risk. We finally describe the influence of FX volatility on international trade volume. KRW rate volatility of trade opponent has a significant negative effect on trade volume, overall. This effect, however, depends on trading partners. It is more significant in the trade with OECD members, but not in the trade with Asian countries.