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A Real Options Approach to Economic Exposure Management
Author(s) -
Capel Jeannette
Publication year - 1997
Publication title -
journal of international financial management and accounting
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.818
H-Index - 37
eISSN - 1467-646X
pISSN - 0954-1314
DOI - 10.1111/1467-646x.t01-1-00018
Subject(s) - downside risk , volatility (finance) , economics , profit (economics) , financial distress , risk management , business , microeconomics , financial economics , finance , portfolio , financial system
Exchange rate volatility is not only a source of concern for firms but also of profit opportunities. If adjustment costs and lags are low, managers can adjust their input or output decisions to raise the firm’s expected profits. Notwithstanding the resulting higher profit variability, the actual risk perceived by the managers may fall as they are probably more averse to downside risk—such as financial distress—than to risk in general. Hence, this paper argues that optimal economic exposure management consists of exploiting the upward profit potential of real exchange rate volatility, while keeping downside risk under control. It is shown that option theory provides useful new principles for economic exposure management by bringing out the crucial role of adjustment costs.