Interactive trilateral foreign exchange exposure: insights from scenario analysis

Abstract

Purpose

The purpose of this paper is to present scenarios of interactive trilateral foreign exchange (FX) exposure, where a company’s exposures to two foreign currencies depend on those currencies’ FX rate with each other.

Design/methodology/approach

A pro forma analysis of three-way FX rate changes illustrates interactive trilateral FX exposure and generates observations for a multivariate regression estimation of FX exposure coefficients.

Findings

The multivariate regression estimates of FX exposure provide the basis for a useful financial hedging strategy for interactive trilateral FX exposure. Some of the FX exposure estimates have surprising signs and magnitudes.

Research limitations/implications

Scenario analysis does not result in a general theory of interactive FX exposure, but the study’s diverse and rich scenarios may provide helpful insights to theoretical and empirical researchers.

Practical implications

The scenarios relate to many common real-world situations and thus may help managers and educators better understand how to manage FX exposure.

Originality/value

The topic of interactive FX exposure is under-researched and under-covered in contemporary textbooks or the applied finance literature.

Citation

O’Brien, T. (2019), "Interactive trilateral foreign exchange exposure: insights from scenario analysis", Managerial Finance, Vol. 45 No. 7, pp. 856-868. https://doi.org/10.1108/MF-11-2018-0566