Executive Summary
We address questions that are central to understanding New Zealand firms' export performance: To what extent are exporters exposed to currency volatility and to which currencies are they most exposed? How do exporters hedge these exposures? Do some or all firms hedge? Do different types of firm display different hedging practices? Is hedging consistent over the exchange rate cycle or do some exporters selectively hedge when the exchange rate or the "cost" of hedging (forward points) reach historical extremes? Has selective hedging been a profitable strategy for New Zealand exporters?
Firms face many risks. One set of risks faced by exporters and other firms relates to variability in earnings due to exchange rate changes. A long-standing theorem in finance (Modigliani and Miller, 1958) suggests that hedging these risks adds nothing to expected firm value; given any positive cost of hedging they should therefore be left unhedged. In practice, however, many firms do hedge currency exposures. Recent finance literature proposes certain circumstances where costly hedging may constitute optimal behaviour. In these circumstances, certain classes of firm may consistently choose to hedge and others to remain unhedged. Recent international research also suggests that some firms may "selectively hedge", i.e. choose hedge positions in an attempt to "time the market".
Very little has hitherto been known about the currency hedging behaviour of New Zealand firms. We examine hedging behaviour across all New Zealand merchandise exporters over a ten year period using data available on a daily basis for all exporters at the 10-digit commodity level. We are able to link the export and currency hedging behaviour of exporters to the same firms' financial data derived from Statistics New Zealand's newly compiled Longitudinal Business Database (LBD). All such data have been obtained on a confidentialised basis so that we are not aware of the identity of any individual firm. We use these data sources to compile descriptive statistics regarding both the currencies of denomination of New Zealand's merchandise exports and firms' currency hedging behaviour. We also test hypotheses concerning the presence, and impacts, of selective hedging.
Approximately 40% of export transactions are denominated in New Zealand dollars (NZD); this ratio drops to around 20% for export values. Of foreign currency exports, the largest proportion is denominated in US dollars (USD) with Australian dollars (AUD) being the next largest currency of denomination. The proportion of non-NZD transactions that is hedged changes over time. The proportion is both variable over short time-spans and, especially in the case of the USD exposures, appears to have increased over time. Hedging generally appears to be for short periods.
Considerable differences emerge in hedging behaviour across different sectors. In a dynamic sense, we find that the Agriculture and Forestry sectors have positively correlated hedge ratios, as do Mining and Manufacturing firms. Large firms (by sales) hedge to the greatest degree; perhaps surprisingly, small firms are the next most comprehensive hedgers. Intermediate-sized firms hedge a lower proportion of currency exposures than either large or small firms. This may reflect a non-linearity in the underlying forces affecting optimal hedging behaviour including scale (favouring hedging by large firms) and costs of financial distress (potentially favouring hedging by small firms). The relationship between hedging and export intensity is, however, monotonic, with hedging ratios increasing as export intensity increases.
We find strong evidence of selective hedging, particularly for AUD exposures. Throughout the sample, hedge ratios are consistently negatively related to the value of the AUDNZD cross rate, consistent with exporters locking in perceived low exchange rates. The same behaviour is observed over the first half of the sample for USD exposures, but not over the second half of the sample (2002 onwards). Our results imply that selective hedging is more pronounced for large exporters than small exporters. The difference in selective hedging between AUD and USD exposures over the latter half of the sample may reflect the behaviour of the two exchange rates. The AUDNZD has moved within a much smaller band, and with a greater degree of reversion to the mean, than has the USDNZD. This may have encouraged firms to believe that they can predict future movements of the NZDAUD with some accuracy whereas this is not the case with the more volatile USDNZD.
We find no evidence that changes in forward points alter hedging decisions. Nor do we find any evidence that selective hedging behaviour is positive for firms; specifically there is no explanatory power of hedging practices for future exchange rate changes. This result is robust across sample periods, currencies and alternative measures of hedging that weight small and large exporters differently.
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