The Behavioral Bias of Foreign Debt Usage in Foreign Exchange Risk Management

Research output: Contribution to conferencePaperResearchpeer-review

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The Behavioral Bias of Foreign Debt Usage in Foreign Exchange Risk Management. / Aabo, Tom.

2010. Paper presented at Behavioural Finance Working Group Conference, London, United Kingdom.

Research output: Contribution to conferencePaperResearchpeer-review

Harvard

Aabo, T 2010, 'The Behavioral Bias of Foreign Debt Usage in Foreign Exchange Risk Management', Paper presented at Behavioural Finance Working Group Conference, London, United Kingdom, 01/07/2010 - 02/07/2010.

APA

Aabo, T. (2010). The Behavioral Bias of Foreign Debt Usage in Foreign Exchange Risk Management. Paper presented at Behavioural Finance Working Group Conference, London, United Kingdom.

CBE

Aabo T. 2010. The Behavioral Bias of Foreign Debt Usage in Foreign Exchange Risk Management. Paper presented at Behavioural Finance Working Group Conference, London, United Kingdom.

MLA

Aabo, Tom The Behavioral Bias of Foreign Debt Usage in Foreign Exchange Risk Management. Behavioural Finance Working Group Conference, 01 Jul 2010, London, United Kingdom, Paper, 2010.

Vancouver

Aabo T. The Behavioral Bias of Foreign Debt Usage in Foreign Exchange Risk Management. 2010. Paper presented at Behavioural Finance Working Group Conference, London, United Kingdom.

Author

Aabo, Tom. / The Behavioral Bias of Foreign Debt Usage in Foreign Exchange Risk Management. Paper presented at Behavioural Finance Working Group Conference, London, United Kingdom.

Bibtex

@conference{23c01b006a2911dfaf9d000ea68e967b,
title = "The Behavioral Bias of Foreign Debt Usage in Foreign Exchange Risk Management",
abstract = "We investigate the behavioral bias in the use of debt denominated in foreign currency (foreign debt) in managing foreign exchange risks. From a strictly financial (rational) point of view foreign debt and derivates are close substitutes. Whether e.g. a European firm sells forward US dollars against Euro (forward contract) or borrows in US dollars (foreign debt) instead of borrowing in Euro makes no difference in foreign exchange exposure terms. Accordingly, G{\'e}czy et al. (1997) note that foreign debt can act as a hedge of foreign revenues and displace the need to hedge with derivatives. We analyze foreign exchange risk management in medium-sized, non-financial firms in Denmark and find a behavioral bias in the use of foreign debt. Among the firms that are internationally involved (operating revenues, costs and/or assets in foreign currency), on average a quarter of the financial debt is denominated in foreign currency. The use / non-use of foreign debt is positively related to a number of internationality measures but most significantly to the existence of subsidiaries abroad whereas the degree of usage is particularly related to the magnitude of foreign operating assets. The use of foreign debt distinguishes itself from the use of shortsighted currency derivatives such asforward contracts by not being significantly and positively related to the foreign sales ratio in a multivariate setting. Furthermore, while the degree of matching at the firm level - creating offsetting operating revenues and costs in the same currency - reduces the use of shortsighted financial derivatives, no such impact is detected for the use of foreign debt.Thus, we highlight that in its practical application for the management of foreign exchange risks a close substitution between foreign debt and derivatives is an illusion rather than the reality. The use of foreign debt is behaviorally biased and related to the financing / hedging of foreign assets and subsidiaries (stocks) rather than to the hedging of the economic exposure from foreign sales (flows). As such, the behavioral bias may - at least to some degree - be a result of mental bookkeeping on the balance sheet at the expense of a forward looking view of cash flows. The findings are important tofirms in other countries with open economies where foreign debt is also used extensively.",
keywords = "Exchange rate exposure management, Foreign debt, Behavioural finance",
author = "Tom Aabo",
year = "2010",
language = "English",
note = "null ; Conference date: 01-07-2010 Through 02-07-2010",

}

RIS

TY - CONF

T1 - The Behavioral Bias of Foreign Debt Usage in Foreign Exchange Risk Management

AU - Aabo, Tom

PY - 2010

Y1 - 2010

N2 - We investigate the behavioral bias in the use of debt denominated in foreign currency (foreign debt) in managing foreign exchange risks. From a strictly financial (rational) point of view foreign debt and derivates are close substitutes. Whether e.g. a European firm sells forward US dollars against Euro (forward contract) or borrows in US dollars (foreign debt) instead of borrowing in Euro makes no difference in foreign exchange exposure terms. Accordingly, Géczy et al. (1997) note that foreign debt can act as a hedge of foreign revenues and displace the need to hedge with derivatives. We analyze foreign exchange risk management in medium-sized, non-financial firms in Denmark and find a behavioral bias in the use of foreign debt. Among the firms that are internationally involved (operating revenues, costs and/or assets in foreign currency), on average a quarter of the financial debt is denominated in foreign currency. The use / non-use of foreign debt is positively related to a number of internationality measures but most significantly to the existence of subsidiaries abroad whereas the degree of usage is particularly related to the magnitude of foreign operating assets. The use of foreign debt distinguishes itself from the use of shortsighted currency derivatives such asforward contracts by not being significantly and positively related to the foreign sales ratio in a multivariate setting. Furthermore, while the degree of matching at the firm level - creating offsetting operating revenues and costs in the same currency - reduces the use of shortsighted financial derivatives, no such impact is detected for the use of foreign debt.Thus, we highlight that in its practical application for the management of foreign exchange risks a close substitution between foreign debt and derivatives is an illusion rather than the reality. The use of foreign debt is behaviorally biased and related to the financing / hedging of foreign assets and subsidiaries (stocks) rather than to the hedging of the economic exposure from foreign sales (flows). As such, the behavioral bias may - at least to some degree - be a result of mental bookkeeping on the balance sheet at the expense of a forward looking view of cash flows. The findings are important tofirms in other countries with open economies where foreign debt is also used extensively.

AB - We investigate the behavioral bias in the use of debt denominated in foreign currency (foreign debt) in managing foreign exchange risks. From a strictly financial (rational) point of view foreign debt and derivates are close substitutes. Whether e.g. a European firm sells forward US dollars against Euro (forward contract) or borrows in US dollars (foreign debt) instead of borrowing in Euro makes no difference in foreign exchange exposure terms. Accordingly, Géczy et al. (1997) note that foreign debt can act as a hedge of foreign revenues and displace the need to hedge with derivatives. We analyze foreign exchange risk management in medium-sized, non-financial firms in Denmark and find a behavioral bias in the use of foreign debt. Among the firms that are internationally involved (operating revenues, costs and/or assets in foreign currency), on average a quarter of the financial debt is denominated in foreign currency. The use / non-use of foreign debt is positively related to a number of internationality measures but most significantly to the existence of subsidiaries abroad whereas the degree of usage is particularly related to the magnitude of foreign operating assets. The use of foreign debt distinguishes itself from the use of shortsighted currency derivatives such asforward contracts by not being significantly and positively related to the foreign sales ratio in a multivariate setting. Furthermore, while the degree of matching at the firm level - creating offsetting operating revenues and costs in the same currency - reduces the use of shortsighted financial derivatives, no such impact is detected for the use of foreign debt.Thus, we highlight that in its practical application for the management of foreign exchange risks a close substitution between foreign debt and derivatives is an illusion rather than the reality. The use of foreign debt is behaviorally biased and related to the financing / hedging of foreign assets and subsidiaries (stocks) rather than to the hedging of the economic exposure from foreign sales (flows). As such, the behavioral bias may - at least to some degree - be a result of mental bookkeeping on the balance sheet at the expense of a forward looking view of cash flows. The findings are important tofirms in other countries with open economies where foreign debt is also used extensively.

KW - Exchange rate exposure management

KW - Foreign debt

KW - Behavioural finance

M3 - Paper

ER -