Chapter III Striving for Home Advantages? An Empirical Study of Currency Hedging
3.6.3 Empirical Results of the Relationship between Currency Hedging and ROE
3.6.3 Empirical Results of the Relationship between Currency Hedging and ROE (ROA)
In this subsection, we further examine the relation between currency hedging and Return On Equity (ROE) and Return On Assets (ROA).Table 3.9 reports the estimated results where the dependent variable is replaced by ROE or ROA. Results show that
FinR and LevR can explain ROE while LevR, Asset, Prem can explain ROA. Thus, high
leverage ratio does not necessarily imply high ROE and ROA. This phenomenon may due to the negative interest rate problem. It is worthy to investigate whether the companies with negative net worth are allowed to increase their foreign investment.Table 3.9 The Relationship among Currency Hedging and Economy of Scale (OLS)
ROE ROA
1. ***significance level 1%, ** significance level 5%,* significance level 10%, ( ) t-value 2. ROE = Profits / Shareholder's Equity. ROA: = Profits / Total Assets.
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3.7 Concluding Remarks
Two opposing views debate whether international investment portfolios should have currency hedging strategies. Financial reporting and regulatory requirements have made insurers more sensitive to the risks inherent in their asset and liability portfolios. The most prominent changes have been the adoption of Risk-Based Capital (RBC) requirements and the implementation of SFAS No.34. Taiwan life insurance industry provides a natural experiment for investigating the relationship between hedging and investment performance for a number of reasons: (1) the foreign investment allocation has increased from 4.62% to 27.21% between 2000 and 2004. The international asset ratio already exceeded 30% in 2008. The life insurance industry is exposed to foreign currency risk, and currency risk affects financial report performance for all insurers; (2) Capital regulations changed from fixed amount to RBC requirements in 2003, and SFAS No.34 was implemented in 2006. These changes affect life insurers’ asset-liability management. Therefore, currency hedging instrument evaluation changed from off balance sheet to mark to market, and exchange volatility and hedging effectiveness affect financial report performance; (3) The differential requirement regarding the need to publicly issue stocks for domestic-owned and foreign-owned firms affects the volatility tolerance of the currency risk on income statements. Hence the hedging strategy of the Taiwan insurers is examined to test whether these strategies have any impact on investment performance.
This chapter examines the impact of currency hedging strategies on the investment performance of Taiwan life insurance industry from 2004 to 2008. The regression results show that currency hedging strategies yield positive results.
However, if the life insurance industry is divided into two categories according to the ownership structure, i.e., domestic-owned and foreign-owned companies, the results show that the currency hedging strategies employed by the domestic-owned companies have more advantages than those of the foreign-owned firms. However, if the life insurers are divided according to their common stock listed on the TAIEX and
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others, the results show that hedging strategy has a positive effect. The results support the managerial discretion hypothesis and also confirm that SFAS No. 34 has significant affects on the currency hedging behaviors for the domestic-owned and stock listed companies. Currency risk management significantly affects Taiwan life insurance firms’ investment performance.
The policy implications are as follows:
1. To reduce negative interest-rate spread problem, international diversification of asset allocation can enhance investment performance, but concentration of currency in USD makes currency risk management difficult.
2. Foreign asset allocation is mostly held long term, but currency hedging derivative transactions need to be marked to market monthly. Financial asset evaluation by SFAS No. 34 leads Taiwan life insurance firms to hedge currency risk just for financial reporting purposes, rather than to control real currency risk. We suggest that the Financial Supervisory Commission adopt a suitable life insurance accounting rule to reduce currency risk hedging result distort financial report information.
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Chapter IV
Conclusions and Future Research
This dissertation attempts to examine the international asset allocation and the currency hedging strategy for Taiwan life insurer industry. When the dot-com boom burst in late 2000, the global economy suffered a downturn that impacted on economic performance worldwide, including Taiwan. As a result, the Central Bank of Taiwan pursued a low-interest rate policy to stimulate economy. Life insurance companies confronted severe negative interest-rate spread problem. To alleviate problems stemming from the negative interest-rate spread problem, Taiwan life insurance companies gradually increased share of their foreign asset investment. By the end of 2009, the foreign investment rate of Taiwan life insurance companies collectively reached 32.17% of life insurance enterprise total funds, amounting to NT$2.98 trillion.
In the first essay, we follow previous literature of internationally diversified portfolios and home bias to further investigate whether the high percentage of foreign investments placed by Taiwan life insurers is a myth or a reality? We find that foreign investment is profitable for the life insurance industry. We also find that global financial turmoil in 2008 had a massively negative impact on the foreign investments of Taiwan life insurance companies.
In the second essay, following literature of international investment portfolios, currency hedging strategy and hedging motive, we investigate the currency hedging strategy and its impact on the performance of Taiwan life insurance industry investments from 2004 to 2008. We find that currency hedging strategies create profits for the industry. Empirical results also show that a hedging strategy has positive effects on domestic-owned company and listed company. Our findings are in line the work in Glen and Jorion (1993) and Campbell et al. (2010), which reveal that hedging strategies improve foreign investment returns and can reduce currency risks in comparison to non-hedging strategies. Our empirical results indicate that financial
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reporting and regulatory requirements made insurers more sensitive to the risks inherent in their asset and liability portfolios.
In sum, our empirical results indicate that international diversification of asset allocation can improve investment performance, but concentration of currency in USD makes currency risk management difficult. Financial asset evaluation by SFAS No.
34 leads Taiwan life insurance firms to hedge currency risk just for financial reporting purpose rather than to control real currency risk. We recommend Financial Supervisory Commission to regulate a life insurance accounting rule to reduce currency risk hedging distortion of financial report.
For the future works with regard to the relationship between hedging strategies and foreign investment, researchers may take account of whether capital regulation affects life insurance foreign investment hedging ratio and of whether board of directors influences hedging strategies. Also, the effects of past hedging performance and risk tolerance on hedging strategy may also be potential determinants of hedge-investment relation. It is also worth to investigate the hedging behavior between state-own and private companies. In addition, it may be interest to investigate whether the managers employed by insurance subsidiaries have incentive to hedge.
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