Measuring Efficiency of South American Foreign Exchange Derivatives Market in Minimizing Currency Risk: A Lesson for Bangladesh

This paper attempts to reveal whether the foreign exchange (FX) derivatives market effectively and efficiently reduces the volatility to foreign exchange rate fluctuations. Cross-country evidence suggests that development of the FX derivatives market does not boost up spot exchange rate volatility and reduce aggregate exposure to currency risk. Intraday evidence for Chile shows that activity in the forward market has not been associated with higher volatility in the exchange rate following the adoption of a floating exchange rate regime. We also find no evidence that net positions of large participants in the FX derivatives market help to predict the exchange rate. These findings support the view that development of the FX derivatives market is valuable to reduce aggregate currency risk. Although in Bangladesh, the use of currency derivatives to hedge foreign exchange risk is not popular among the existing firms engaged in foreign exchange transactions, there are a few firms such as ACI and General Motors with extensive foreign exchangerate exposure and economies of scale in hedging activities, which are more likely to use currency derivatives. This is because, given the potential shifts in the supply of or demand for currency, firms and individuals who have assets denominated in foreign currencies can be affected favorably or unfavorably. These firms may want to alter their currency exposure in order to grab benefit or hedge risk from the expected movements of exchange rates. This study provides a detailed analysis along with a background on currency derivatives which are commonly used by some of large firms existing in Bangladesh in order to capitalize on or hedge against expected exchange rate exposures measured by these firms. In this paper, we have also divulged an analytical framework for measuring exchange rate exposures accelerating the use of currency derivatives in foreign exchange market of Bangladesh.