Research On Foreign Exchange Derivatives Market In China

On July 21,2005, the People’s Bank of China (PBC) started a new round reform of the RMB exchange rate regime. Since then, as one of basic economic resources and financial asset prices, the RMB exchange rate has widely affected the China’s economic development and domestic financial market operation, and also become important factor influencing the world economy and global financial markets. In order to cope with the rising of the RMB exchange rate fluctuations, the PBC gradually built up foreign exchange derivatives market in the domestic inter-bank foreign exchange market. China’s foreign exchange derivatives market belongs to the OTC derivatives market.Comparing with the rapid development of foreign exchange derivatives market in China, the study on this market just started in domestic academia. On one hand, there is the lack of systematic theoretical research, and on the other hand lack of corresponding empirical tests. This paper tries to make up for the blank field in the related literature. This paper selected the micro motivations, economic effects, and government regulation, which are different but closely inter-linked. The study is based on the optimal hedging theory, monetary policy transmission theory, financial function theory and financial regulation theory, through making the econometric models, macro-economics model, the game theory model and partial equilibrium analysis model. The research launchs from the micro level, then to macro level, and finally to regulation level in turn. This paper attempts to construct the analysis framework and theoretical system on the foreign exchange derivatives market with Chinese characteristics.Based on the comprehensive analysis and extension of the optimal hedging theory, the paper studies the micro motivations for using foreign exchange derivatives, and the effects of foreign exchange derivatives on the firm value and risk taking, by selecting manufacturing companies and commercial banks listed in A-share stock market during the period from 2007 to 2013. Then, through making of theoretical models and SVAR model as well as BVAR model using China’s macro monthly data, the paper investigates the impact of the foreign exchange derivatives market on monetary policy exchange rate transmission channels and international trade in China. Finally, by constructing evolutionary game model and partial equilibrium analysis model, the paper analyzes government regulation of the foreign exchange derivatives market and its international regulation cooperation.The paper finds that there are similarities and differences in the theoretical research and China’s empirical evidences in the micro motivations of using foreign exchange derivatives. Among them, the exchange rate risk exposure has a positive effect on foreign exchange derivatives use, but significance level of the effect in the manufacturing companies changes with the different level of exchange rate risk exposure. In the detail, the effect is significant in the large exchange rate risk exposures, on the contrary in the small risk exposures this effect is insignificant. In commercial banks, the effect has the structural differences in the currencies, which means the effect of US dollar exchange rate risk exposure is greater than the non US dollar in the scale and significance. At the same time, there are significant scale and scope economy in the foreign exchange derivatives usages. However, in manufacturing companies, profitability has significantly positive influence on the derivatives usages, and investment opportunities produces negative effects; in commercial banks, liquidity and capital adequacy bring the significant positive effect on the use of derivatives, these findings has the obvious difference with theoretical analysis. In addition, financial leverage, tax burden and liquidity level are not the important factors affecting foreign exchange derivatives usage in manufacturing enterprises. Meanwhile, profitability, tax burden, non-performing loan ratio, growth ability and the change of exchange rate are not the main factors determining the derivatives trading in commercial banks.For the listed company, firm value (representing by Tobin Q) is globally recognized index of the enterprise performance evaluation. In the paper, the empirical evidences shows that in the manufacturing companies, foreign exchange derivatives have the positive effects on the firm value but the scale of effect is small and not statistically significant. In China’s commercial banks, there is a significantly negative effect made by foreign exchange derivatives. As the proportion of foreign exchange derivatives to the total assets increases 1%, firm value declines more than 0.18%. At the same time, it also finds that the global financial crisis changes the firm value effects of the foreign exchange derivatives. For manufacturing companies, in 2007-2009 during the financial crisis there was not significant premium effect, during the post financial crisis in 2010-2013, foreign exchange derivatives produced insignificantly negative effect. For commercial banks, during the financial crisis there is the insignificantly negative effect, and otherwise in the post financial crisis there is the significant premium effect.The paper finds that in the manufacturing companies foreign exchange derivatives can significantly reduce the systematic risk and idiosyncratic risk. However, for the impact on the systematic risk, there is difference in the sample firms in the mainboard, SME board, and second board. For the firms in the mainboard, the impact is significantly negative, while the impact becomes insignificantly positive in the SME and second board companies. For the firms in each board market, the foreign exchange derivatives have insignificantly negative effects on the idiosyncratic risk. For commercial banks, derivatives make the significantly positive effect on pre-risk and post-risk. Meanwhile, the effect on bank’s post risk is higher than the pre-risk in the scale.Through building macroeconomics model and analyzing empirically the monthly data, the paper finds that the monetary policy exchange transmission channel was shocked with the emergence of China’s foreign exchange derivatives market. The macroeconomics model incorporating exchange rate risk hedging implies that using foreign exchange derivatives to hedge currency risk in firms will lead to reduce the sensitivity of a country’s net exports to exchange rate and even revert. Empirical studies show that by comparing with the periods with and without the foreign exchange derivatives market, the sensitivity of the net export to the RMB exchange rate has changed significantly. Without the foreign exchange derivatives market in China, the appreciation of the RMB caused to decrease in China’s total net exports and China’s net exports to the US and the EU. In the contrast, with the emergence of the market in China, the effect of the RMB appreciation on China’s net exports to the US became from negative to positive. Meanwhile, there was the reduction in the negative impact of the RMB appreciation on China’s total net exports and China’s net exports to the EU.Based on the theoretical model and empirical analysis with the China’s monthly macro data, this paper proves that foreign exchange derivatives can bring the positive effects on international trade. It makes a two-stage Cournot game model under the exchange rate uncertainty, and uses backward induction and subgame-perfect Nash equilibrium. The model implies that foreign exchange derivatives hedging exchange rate risk have the positive effect on export and import level of the firm if the von Neumann-Morgenstern utility function of the firm displays either constant or decreasing absolute risk aversion. The empirical evidence displays that there is an expansion of the export and the import volume due to increase in foreign exchange derivatives market transaction volume in the short run and the long run. Furthermore, the market transaction volume accounts for 15 percent of the variability in the export volume and 20 percent of the variability in the import volume in the long run.Based on the evolutionary game model with the bounded rationality, the paper studies the strategies selection, the evolution of the trajectory, and the determinants in the foreign exchange derivatives market traders and regulators. The model shows that there is a certain proportion in the market traders choosing speculative trading so that the government as the regulator must strengthen the market regulation. At the same time, both the proportion of speculative trading and the possibility of strengthening regulation have the threshold values. When the proportion of speculative trading is larger than the threshold value, regulators tend to strengthen supervision. While the probability of strengthening regulation exceeds the threshold value, the traders will tend to give up the speculative trading. Finally, these threshold values are constrained by benefit and cost of trading and regulation.By building a partial equilibrium model, the paper investigates the equilibrium of foreign exchange derivatives market in the global financial system, and analyzes the relationship among the risk level, transaction volume and the government utility. The results imply that under the international regulation competition, the risk level of foreign exchange derivatives market is higher than the minimum, but the international regulatory cooperation can make the market risk level minimum. In addition, international regulation cooperation makes both the global utility and a single country’s utility higher than the levels under the international regulation competitions. It is proved that international regulation cooperation is better than regulation competition in foreign exchange derivatives market.Based on the conclusion and the current status of the foreign exchange derivatives market in China, the paper puts forward five policy recommendations. First, the government needs to launch RMB currency futures as soon as possible and can consider carrying out the pilot of foreign exchange futures in the free trade pilot zones. Second, by learning the COSO enterprise risk management framework, the domestic enterprises and commercial banks can improve and promote the risk management mechanism in foreign exchange derivatives. Third, the central bank should actively monitor and make full use of foreign exchange derivatives markets, in order to improve the effectiveness of monetary policy in China. Fourth, government needs to strengthen the regulation on foreign exchange derivatives market, and firmly hold the bottom line that there never take place the systemic and regional financial risk. Finally, all countries should strengthen regulation cooperation in the foreign exchange derivatives market together, and solve the dilemma between the market globalization and regulation localization.Compared with the existing literature, the innovations of the paper are multi-dimensional, including the novelty on the research framework, the breakthrough on the content, innovation on the modeling, representative empirical samples, and completeness of policy suggestions.