Exchange Rate Arrangements and the Hedging Problem in East Asia

This paper studies the hedging decisions faced by East Asian importers and exporters exposed to foreign exchange risk. The study includes a critical review on the historical development of the exchange rate arrangements in East Asia during the past decade. Assuming that financial markets are incomplete and some relevant financial exchange markets do not exist, a theoretical model for the East Asian hedging problem is then constructed. It is fitted empirically to the East Asian data. Increased exchange rate variability leads domestic importers and exporters to hedge less amounts of their foreign-currency exposures through forward covering. The final result shows the advantages of a strong US dollar zone in East Asia. Acknowledgement: This study is a collaborative effort and I am immensely grateful to a remarkable group of people: Prof. Ronald McKinnon, my advisor, for providing me the inspiration and the freedom to develop my own analytical perspective through this study. Prof. Geoffrey Rothwell for his heartfelt support and commitment. Slavi Slavov for his invaluable mentorship through the research process. And above all, my family for the infinite love and support. 1