IDEAS home Printed from https://ideas.repec.org/a/kap/ejlwec/v34y2012i2p391-412.html
   My bibliography  Save this article

Contracting foreign exchange rate risks: a behavioral law and economics perspective on KIKO forward contracts

Author

Listed:
  • Haksoo Ko
  • William Moon

Abstract

Between 2006 and 2007, hundreds of export-oriented South Korean companies entered into what are called KIKO (knock-in, knock-out) target forward contracts to hedge against the threat of an appreciating Korean currency, the Won. Buyers of these contracts were assured a pre-determined foreign exchange rate as long as the range of exchange rate fluctuation stayed within a narrow band. In 2008, however, the Korean currency depreciated considerably following the global financial crisis, forcing buyers of the KIKO contracts to incur enormous losses. Why were there both supply and demand for these contracts, and why did they become suddenly popular? This article employs a behavioral law and economics perspective to explain what transpired in the minds of the parties to the contracts. Psychological biases and cognitive limitations were perhaps at play, including herd behavior, investor myopia, information cascades, and optimism bias. Recognizing that these psychological factors could induce sub-optimal decisions of the contracting parties, we argue that de-biasing should be considered an important policy goal in financial contracting. While the scope of this paper is limited to the KIKO contracts, the principles used to examine this case can be broadly applied. Copyright Springer Science+Business Media, LLC 2012

Suggested Citation

  • Haksoo Ko & William Moon, 2012. "Contracting foreign exchange rate risks: a behavioral law and economics perspective on KIKO forward contracts," European Journal of Law and Economics, Springer, vol. 34(2), pages 391-412, October.
    • Handle: RePEc:kap:ejlwec:v:34:y:2012:i:2:p:391-412
    DOI: 10.1007/s10657-010-9204-9
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/10.1007/s10657-010-9204-9
    Download Restriction: Access to full text is restricted to subscribers.
    File URL: https://libkey.io/10.1007/s10657-010-9204-9?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Heath, Chip & Jourden, Forest J., 1997. "Illusion, Disillusion, and the Buffering Effect of Groups," Organizational Behavior and Human Decision Processes, Elsevier, vol. 69(2), pages 103-116, February.
    2. Isard,Peter, 1995. "Exchange Rate Economics," Cambridge Books, Cambridge University Press, number 9780521466004, October.
    3. Sarno,Lucio & Taylor,Mark P., 2003. "The Economics of Exchange Rates," Cambridge Books, Cambridge University Press, number 9780521485845, October.
    4. Levin, Irwin P & Gaeth, Gary J, 1988. "How Consumers Are Affected by the Framing of Attribute Information before and after Consuming the Product," Journal of Consumer Research, Journal of Consumer Research Inc., vol. 15(3), pages 374-378, December.
    5. Shiller, Robert J, 1995. "Conversation, Information, and Herd Behavior," American Economic Review, American Economic Association, vol. 85(2), pages 181-185, May.
    6. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
    7. Abhijit V. Banerjee, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 107(3), pages 797-817.
    8. Isard,Peter, 1995. "Exchange Rate Economics," Cambridge Books, Cambridge University Press, number 9780521460477, October.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Kim, Sungjae F. & Chance, Don M., 2018. "An empirical analysis of corporate currency risk management policies and practices," Pacific-Basin Finance Journal, Elsevier, vol. 47(C), pages 109-128.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Martin D.D. Evans & Richard K. Lyons, 2017. "Order Flow and Exchange Rate Dynamics," World Scientific Book Chapters, in: Studies in Foreign Exchange Economics, chapter 6, pages 247-290, World Scientific Publishing Co. Pte. Ltd..
    2. Otavio De Medeiros, 2005. "Order Flow and Exchange Rate Dynamics in Brazil," Finance 0503019, University Library of Munich, Germany.
    3. Zhang, Hui Jun & Dufour, Jean-Marie & Galbraith, John W., 2016. "Exchange rates and commodity prices: Measuring causality at multiple horizons," Journal of Empirical Finance, Elsevier, vol. 36(C), pages 100-120.
    4. Works, Richard Floyd, 2016. "Econometric modeling of exchange rate determinants by market classification: An empirical analysis of Japan and South Korea using the sticky-price monetary theory," MPRA Paper 76382, University Library of Munich, Germany.
    5. Makin, Anthony J., 2013. "Commodity prices and the macroeconomy: An extended dependent economy approach," Journal of Asian Economics, Elsevier, vol. 24(C), pages 80-88.
    6. Schröder, Michael & Dornau, Robert, 1999. "What's on their mind: do exchange rate forecasters stick to theoretical models?," ZEW Discussion Papers 99-08, ZEW - Leibniz Centre for European Economic Research.
    7. Paul De Grauwe & Marianna Grimaldi, 2014. "Exchange Rate Puzzles: A Tale of Switching Attractors," World Scientific Book Chapters, in: Exchange Rates and Global Financial Policies, chapter 3, pages 71-117, World Scientific Publishing Co. Pte. Ltd..
    8. Pippenger, John, 2004. "The Modern Theory of the LOP and PPP: Some Implications," University of California at Santa Barbara, Economics Working Paper Series qt60z886n7, Department of Economics, UC Santa Barbara.
    9. Sergio Da Silva, 2004. "International Finance, Levy Distributions, and the Econophysics of Exchange Rates," International Finance 0405018, University Library of Munich, Germany.
    10. Oscar Bajo Rubio & María Dolores Montávez Garcés, 1998. "Tipo de cambio, expectativas y nueva información: evidencia para el caso de la peseta, 1986-1996," Documentos de Trabajo - Lan Gaiak Departamento de Economía - Universidad Pública de Navarra 9801, Departamento de Economía - Universidad Pública de Navarra.
    11. Clements, Kenneth & Lan, Yihui & Roberts, John, 2008. "Exchange-rate economics for the resources sector," Resources Policy, Elsevier, vol. 33(2), pages 102-117, June.
    12. Haberer, Markus, 2004. "Might a Securities Transactions Tax Mitigate Excess Volatility? Some Evidence From the Literature," CoFE Discussion Papers 04/06, University of Konstanz, Center of Finance and Econometrics (CoFE).
    13. Peter Rowland & Hugo OLiveros C., 2003. "Colombian Purchasing Power Parity Analysed Using a Framework of Multivariate Cointegration," Borradores de Economia 252, Banco de la Republica de Colombia.
    14. Richard K. Lyons, 2002. "Foreign exchange: macro puzzles, micro tools," Economic Review, Federal Reserve Bank of San Francisco, pages 51-69.
    15. Menzie D. Chinn & Yi Zhang, 2018. "Uncovered Interest Parity and Monetary Policy Near and Far from the Zero Lower Bound," Open Economies Review, Springer, vol. 29(1), pages 1-30, February.
    16. Simpson, Marc W. & Ramchander, Sanjay & Chaudhry, Mukesh, 2005. "The impact of macroeconomic surprises on spot and forward foreign exchange markets," Journal of International Money and Finance, Elsevier, vol. 24(5), pages 693-718, September.
    17. Peter Rowland, 2002. "Uncovered Interest Parity And The Usd/Cop Exchange Rate," Borradores de Economia 3733, Banco de la Republica.
    18. Samih Antoine Azar, 2008. "The Effect of the Lebanese Peg to the US Dollar on Market Efficiency and Risk," Journal of Emerging Market Finance, Institute for Financial Management and Research, vol. 7(1), pages 1-15, January.
    19. Alan M. Taylor, 1996. "International Capital Mobility in History: Purchasing-Power Parity in the Long Run," NBER Working Papers 5742, National Bureau of Economic Research, Inc.
    20. Menzie D. Chinn & Saad Quayyum, 2012. "Long Horizon Uncovered Interest Parity Re-Assessed," NBER Working Papers 18482, National Bureau of Economic Research, Inc.

    More about this item

    Keywords

    Behavioral law and economics; Foreign exchange forward contracts; Knock-in knock-out contracts; K00; K22;
    All these keywords.

    JEL classification:

    • K00 - Law and Economics - - General - - - General (including Data Sources and Description)
    • K22 - Law and Economics - - Regulation and Business Law - - - Business and Securities Law

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:kap:ejlwec:v:34:y:2012:i:2:p:391-412. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Sonal Shukla or Springer Nature Abstracting and Indexing (email available below). General contact details of provider: http://www.springer.com .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.