multinationals and futures hedging an optimal stopping.pdf

Title Multinationals and futures hedging: An optimal stopping approach Author(s) Meng, R; Wong, KP Citation Global Finance Journal, 2010, v. 21 n. 1, p. 13-25 Issued Date 2010 URL /10722/177776 Rights Creative Commons: Attribution 3.0 Hong Kong License 1 Multinationals and futures hedging: An optimal stopping approach Rujing Meng, Kit Pong Wong∗ School of Economics and Finance, University of Hong Kong, Pokfulam Road, Hong Kong, China ABSTRACT This paper examines the optimal design of a futures hedge program for a risk-averse multinational firm (MNF) under exchange rate uncertainty. All currency futures contracts are marked to market and require interim cash settlement of gains and losses. The MNF commits to prematurely liqui- dating its futures position on which the interim loss incurred exceeds a threshold level (i.e., the liquidation threshold). When the liquidation threshold is exogenously given, we show that the MNF optimally opts for an under-hedge (an over-hedge) should the futures exchange rates be not too (sufficiently) positively autocorrelated. When the liquidation threshold is endogenously determined, we show that the MNF voluntarily chooses to prematurely liquidate its futures position only if the futures exchange rates are positively autocorrelated. In the case that the futures exchange rates are uncorrelated or negatively autocorrelated, the MNF prefers not to commit to any finite liquidation thresholds. JEL classification: D81; F23; F31 Keywords: Futures hedging; Multinationals; Optimal stopping problems 1. Introduction Multinational firms (MNFs) take liquidity risk seriously when devising their risk man- agement strategies. Ignorance of liquidity risk is likely to result