20 04 2020 Exchange Rate Exposure and Risk Management

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Journal of the Japanese and International Economies

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Volume 41, September 2016, Pages 17-29
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Exchange rate exposure and risk management: The case of Japanese
exporting firms ☆
Takatoshi Ito a, b , Satoshi Koibuchi c , Kiyotaka Sato d , Junko Shimizu e
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https://doi.org/10.1016/j.jjie.2016.05.001 Get rights and content
Highlights
• We conducted the questionnaire survey of Japanese firms’ exchange risk
management.
• Large foreign sales and US dollar invoicing lead to greater foreign exchange
exposure.
• Both financial and operational hedging can reduce the foreign exchange exposure.
• Yen invoicing exports can also mitigate the firms’ foreign exchange exposure.
• Japanese firms need to use a combination of the tools to reduce the exchange rate
risk.
Abstract
This paper investigates the relationship between Japanese firms’ exposure to the exchange rate risk and their risk
management. Following Dominguez (1998) and others, we first estimate the firms’ exposure to the exchange rate
risk by regressing their stock prices on the exchange rate and the market portfolio. We next investigate possible
influences of various risk management measures on the firms’ foreign exchange exposure. Risk management
variables include financial and operational hedging, the invoice currency choice, and the price revision strategy
(pass-through) of 227 listed firms in 2009, which were collected from a questionnaire survey of Japanese firms
listed in the Tokyo Stock Exchange. Our main findings are as follows: First, firms with greater dependency on sales
in foreign markets have greater foreign exchange exposure, judged by the market. Second, the higher the US dollar
invoicing share, the greater the foreign exchange exposure is, which can be reduced by both financial and
operational hedging. Third, yen invoicing reduces foreign exchange exposure. These findings indicate that
Japanese firms use a combination of risk management tools to mitigate the degree of exchange rate risk.
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Keywords
Exchange rate risk management; Invoice currency; Operational hedge; Financial hedge; Exchange rate
pass-through
JEL Classification
F31; G15; G32
1. Introduction
A period of strong yen squeezes the profits of Japanese exporters either by lower sales with higher prices, in case
yen appreciation is passed through to retail prices in the destination market, or by a decline in the profit margin, in
case it is not passed through to the destination market. Between 2008 and 2012, the yen appreciated vis-à-vis the
US dollar by more than 30%. Since the yen was floated in 1973, Japanese firms have continuously had concerns
and struggled with yen appreciation, and this time was no exception.
Various ways to manage foreign exchange risk have been developed by the Japanese exporters over time. Even
though some production bases have been moved abroad, significant production capacity remains in Japan. This
production is still exposed to the exchange rate risk—a long-term yen appreciation trend and short-term volatility.
Japanese firms usually use both financial and operational hedges to manage their currency exposure. Financial
hedges are conducted mainly with the use of currency derivatives, while operational hedges are devised in the
firm's international transactions between the head office and foreign subsidiaries. With the development of
financial hedge techniques, such as forward transactions, currency swaps, and currency options, firms can hedge
their currency exposure against foreign exchange risks. However, these transactions, which determine the yen
receipt with certainty if fully hedged, can be used only within a timespan of several months, and with some costs.
Financial hedges cannot be effective in the long-run. In response to the unprecedented level of the strong yen in
the mid-1990 s, Japanese exporting firms have accelerated moving production bases to and expanding those
already located in foreign countries. The firms have also increased the proportion of imported components from
overseas and taken other counter measures to mitigate the damage from the stronger yen1.
It is well-known that Japan is an outlier in the pattern of invoicing currencies. According to “stylized facts” of the
choice of invoice currency, which were developed in the 1970 s following the seminal work of Grassman (1973),
trades between two economically advanced countries tend to be invoiced in the exporter's currency, and trade
between economically advanced and developing countries is generally invoiced in the advanced country's currency.
However, Japan's currency invoicing pattern differs from these stylized facts2. According to the Ministry of Finance
data, Japanese exporters have a strong tendency to choose the importer's currency for their exports to advanced
countries such as the US and EU. For exports to Asia, the US dollar, which is the currency of the third country, is
commonly used. This is one of the reasons why currency risk management is a serious problem among Japanese
firms. If their exports were invoiced in yen, their business performance would not have been affected as much as it
has actually been during the strong yen periods. Besides invoicing, firms can change export prices, even if the
invoicing currency is in yen in the medium-term (in the next export contract period). How often firms adjust
export prices in response to the exchange rate (i.e., pass-through) is a variable that the firms choose to decide. If
firms are so competitive that they can raise their product prices to offset losses from yen appreciation, then the
exchange rate fluctuations would not cause any severe impact on their profit performance. Accordingly, the
medium-term effectiveness of exchange risk management depends on the choice of invoicing currency and the
degree of pass-through, both of which depends on competitiveness of products.
So how can the effectiveness of Japanese firms' exchange rate risk management be measured? One possible way is
to measure each firm's exchange rate exposure, and to investigate the relationship between this exposure and the
exchange rate risk management. We follow previous studies (such as Dominguez (1998) and Doukas et al. (2003))
that have derived exchange rate exposure by estimating the sensitivity of firms’ cash flows to the fluctuations in the
exchange rate. The value of a firm is the present value of its future cash flow stream, and the current exchange rate
variation will affect the cash flows in the future. To date, many empirical studies have used stock price returns as a
proxy for the firm value, and have obtained exchange rate exposure from a regression of stock price returns on an
exchange rate change. Although the issue of how to measure firms’ exposure to the exchange rate fluctuations has
been investigated by many researchers in the field of corporate finance, few existing studies have specifically
undertaken the firm level analysis of the exchange rate exposure and exchange rate risk management including the
choice of invoice currency and pass-through policy.
In order to obtain information on how export firms are coping with the exchange rate fluctuation, a specifically-
designed questionnaire survey was designed and conducted with the cooperation of the Research Institute of
Economy, Trade, and Industry (RIETI). Questionnaires were sent in September 2009 to 920 Japanese
manufacturing firms. They were selected among those listed on the Tokyo Stock Exchange with the criterion that
they reported foreign sales in the consolidated financial statements in fiscal year 2008 and 2009. Our sample firms
are those that responded to the RIETI Survey 2009. We had 227 samples spreading across 15 industries: Food,
Textile, Chemicals, Medicinal Chemicals, Coal and Oil Products, Rubber Products, Glass and Stone Products, Iron
and Steel, Non-Metal Products, Metal Products, General Machinery, Electrical Machinery, Transport Equipment,
Precision Instruments and Other products. The response rate was 25% (=227/920). This survey (hereafter, the
2009 RIETI survey) provided us with new information on these Japanese firms' use of financial and operational
hedging, price revision in response to the exchange rate changes, and choice of invoicing currency. The survey
results are aggregated by industry and by the firm size, using annual financial reports of sample firms. See
Appendix A for the basic information about responding firms.
Our analysis shows how Japanese firms combine three different tools of exchange rate risk management, such as
operational and financial hedging, and exchange rate pass-through under their own choice of invoicing currency, to
reduce their exchange rate exposure. Given a growing regional production network of Japanese firms, our findings
based on the questionnaire study will present important implications for future exchange rate policies to support
more effective exchange rate risk management.
The remainder of this paper is organized as follows. Section 2 reviews earlier literature of firms' foreign exchange
risk management and presents a discussion of the relationship between the variety of exchange rate risk
management and invoicing currency choice conducted by Japanese firms. Section 3 summarizes the stylized facts
of 2009 RIETI Survey related to Japanese firms' exchange rate risk management. Section 4 reviews the
methodology of firm exchange rate exposure and presents our estimation results. Section 5 conducts empirical
analyses to find the relation between exchange rate risk management and the exchange rate exposure. Finally
section 6 concludes this paper.
2. Exchange rate risk management of Japanese firms
2.1. Variety of exchange rate risk management

Numerous empirical studies have examined the question of how firms accommodate or mitigate foreign exchange
risk. Usually, firms use two means to hedge exchange rate risk. One is a financial hedge through financial market
instruments such as exchange rate derivatives or foreign currency debt; and an operational hedge through
operational organization of the exporting firm. To manage long-term exchange rate risks effectively, firms should
build operational hedging strategies in addition to widely used financial hedging strategies. Most studies
specifically examine currency hedging.3 These studies analyze the relation between operational hedging and
financial hedging, and underscore the effectiveness of both strategies by conducting empirical analysis based on
the firms' stock price returns. For example, Pantzalis et al. (2001), using a sample of 220 US multinational firms,
found that operational and financial hedges are complementary risk management strategies. Hommel (2003),
shows that operational hedging creates flexibility, a strategic complement to financial hedging. Allayannis et al.
(2001), also investigate both financial and operational exchange-rate risk management strategies of multinational
firms and confirm that operational hedging strategies benefit shareholders only when used in combination with
financial hedging strategies. Kim et al. (2006) investigate how operational hedging is related to financial hedging.
They confirm that, although operational and financial hedging strategies are complementary, firms using
operational hedging are less dependent on the use of financial derivatives.4
The relationship between invoicing currency and hedging is rarely investigated. The exception was a study by
Döhring (2008), which was the first reported survey study of both the choice of invoicing currency and
financial/operational hedging. Results show that invoicing choice is a substitute for derivative hedging such as
exchange rate forward positions in eliminating transaction risk, and also that firms are expected to opt for either of
them depending on the relative cost of the strategy. Conducting a survey of actual hedging strategies and
techniques of large corporations from a euro-area perspective, Döhring (2008), concludes that whether a domestic
currency invoicing and hedging are substitutes or complements depends crucially on the size and geographical
orientation of the exporting firm and on the structure of the destination market.5
As for recent country-specific studies, Chiang and Lin (2007), examine financial and operational hedge strategies
of foreign exchange exposures using multiple-horizon data of Taiwan non-financial firms during 1998–2005. They
report that the use of operational hedging strategies does not help reduce foreign exchange exposure for Taiwan
firms. Pramborg (2005), compares the hedging practices between Swedish and Korean nonfinancial firms and
shows that Korean firms used much smaller financial derivatives than Swedish firms with more dependence on
foreign debt than derivatives. Both studies describe the difficulties of exchange rate risk management in
underdeveloped foreign exchange markets such as those of Taiwan and Korea. Regarding research using data for
Japan, Jayasinghe and Tsui (2008), examine the exchange rate exposure of sectorial indexes in Japanese
industries and report evidence of exposed returns and their asymmetric conditional volatility of exchange rate
exposure using a bivariate GJR-GARCH model. Although Japanese exporting firms tend to face large volatility in
the yen/US dollar exchange rate, surprisingly few studies conduct firm-level analysis of hedging and exchange rate
risk management with the choice of invoicing currency.
2.2. Japanese firms' feature of currency invoicing and pass through

According to the “stylized facts” related to the choice of invoice currency, which is based on the seminal work of
Grassman (1973), trade between two economically advanced countries tends to be invoiced in the exporter's
currency. Trade between economically advanced and developing countries is generally invoiced in the advanced
country's currency. However, Japan's currency invoicing pattern evidently contradicts the stylized facts. First,
Japanese exporters have a strong tendency to choose the importer's currency for their exports to other advanced
countries such as the United States and EU. Second, US dollar invoicing is prevalent in Japan's exports to Asia.
Many determinants of currency invoicing have been suggested in the literature. The authors typically use data of
the share of currency invoicing at a country level, and correlate them with suspected macroeconomic factors. A
micro-analysis at the firm level is needed to test the relevance of the factors. Only a few exploited the firm level
data. Goldberg and Tille (2009), used highly detailed Canadian import data at a Customs level with rich
information on the source country, invoice currency, value of transactions, etc. The other is a study by Friberg and
Wilander (2008), who conduct a questionnaire survey analysis with Swedish exporting firms for empirical tests on
determinants of currency invoicing, which is a useful approach to obtain detailed data at a firm level.
Another exception is Ito et al. (2010b), who conducted an interview survey of leading Japanese exporters to
overcome a data constraint.6 As the interview survey recovers firm-level information related to exchange rate risk
management, the destination breakdown with respect to the choice of invoice currency became possible. Also, one
question was to reveal whether trades are intra-firm transactions or arms-length transactions—a clear advantage
over macro data. Ito et al., 2010b, Ito et al., 2012), claimed to have found evidence of a wider set of invoice
currency determinants for the Japanese exporters: (1) Intra-firm trade, inter-firm trade, or trade via a trading
company; (2) transaction cost of the currency; (3) the intensity of competition in the export destination markets
and the degree of product differentiation; and (4) the structure of production and distribution network, in which,
for example, goods are produced in Japanese exporters’ subsidiaries in Asia and shipped to the United States as the
final destination.
Intra-firm trade means, for example, the head office in Japan sells automobiles to foreign subsidiaries in the US
and European countries. It was found that invoicing in the importer's currency is prevalent for Japanese intra-firm
exports to advanced countries. Since the exports are destined for local subsidiaries that face severe competition in
the local markets, Japanese parent firms have a strong tendency to take an exchange rate risk by invoicing in the
importer's currency. In fact, it is a rational decision of headquarters to assume all currency risk for its exports to
foreign subsidiaries in different currency areas, because headquarters is better equipped to manage multi-currency
risk with scale economies. Especially if the local subsidiaries, say in Asia, assembles cars and they sell to the US
markets, then their choice of US dollar invoicing is rational as a part of their strategy of global exchange rate risk
management.
Some Japanese firms that export highly differentiated products or which have a dominant share in global markets
tend to choose yen invoicing. In addition, small firms, which have no treasury department because of budget
constraints, usually ask a general trading company to manage their foreign exchange business. In this case, they
also tend to use yen invoicing in their transactions with a trading company; and the trading company, which does
both imports and exports, takes over exchange rate risks. Accordingly, Japanese firms' choice of invoice currency is
rather complicated, but should be considered along with other risk management tools.
As in Bartram et al. (2010), we assume that Japanese firms have four options in managing exchange rate risk: (1)
choice of invoice currency, (2) pricing (pass-through) policy, (3) operational hedging, and (4) financial hedging.
Fig. 1 shows our conceptual diagram of exchange rate risk management, based on which we constructed questions
in the 2009 RIETI survey. We are able to clarify the notable characteristics of Japanese firms’ exchange rate risk
management based on the survey. Compared with the related studies above, the novelty of this paper is that it
describes detailed empirical analysis of the exchange rate risk management of Japanese firms using the four
different tools: invoicing currency choice, pricing (pass through) strategy, operational hedging and financial
hedging.
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Fig. 1. Concept of exchange rate risk management.
2.3. Effectiveness of the Japanese firms' exchange rate risk management
2.3.1. Choice of invoicing currency

As shown in Ito et al., 2010b, Ito et al., 2012), Japanese firms that export highly differentiated products and/or
have a dominant share in global markets tend to choose yen invoicing. If their exports are invoiced in the yen
instead of the US dollar, their business performance would not be affected by a stronger yen at least for a short
time horizon. However, most firms do not have products that are sufficiently competitive to insist on yen invoicing
to the foreign buyers. In general, firms that cannot make exports totally yen invoiced rationally choose risk-
mitigating measures depending on many factors. Factors such as firm size, products, trading partners, trading
countries, and financial characteristics are suspected to influence the counter-measures to exchange rate risk.
2.3.2. With an operational hedge (“marry and netting”)
In the wake of a sharp yen appreciation in 1995, Japanese exporting firms have accelerated transfer and expansion
of production facilities overseas and increased the proportion of imported components from overseas. An increase
in import components are considered an example of “marry and netting,” or part of so-called “operational
hedging.” For firms with higher US dollar invoicing share, “marry and netting” presumably works effectively to
reduce currency exposure. However, not all firms can use this technique. Firms that produce goods made using
Japanese materials only and export them abroad cannot carry out marry netting because they have no payable
foreign currency. In the RIETI 2009 questionnaire, firms are asked whether they engage in “marry and netting” or
more broadly, operational hedging.
2.3.3. Degree of financial hedge (hedging ratio of forward contract)

For firms that have little imported components, another instrument to hedge is financial hedge. It is expected that
the higher the US dollar invoicing share is, the greater is the financial hedge usage to reduce the exchange rate
exposure. In the RIETI 2009 survey, firms were asked whether they engage in financial hedges, and what type of
financial instruments they used. More than 70% of firms are found to use some kind of hedging instrument
through the foreign exchange market. Among them, more than 90% of firms use “forward contracts.” However, no
specific hedging ratio of “Forward contract” exists by industry or firm size. It seems that the hedging ratio depends
on each firm's ability and willingness of the foreign exchange risk management.
2.3.4. Exchange rate pass through

Even when Japanese firms invoice their exports in the US dollar and suffer shrinking profit margins from yen
appreciation, Japanese firms may be able to recover profit margin by raising the dollar-denominated export prices.
This cannot be done too often, but a quarterly revision of export prices seem to be commonly done. When new
models and makes are marketed, prices can easily reflect new exchange rate levels. Whether firms can make their
price revisions in response to foreign exchange fluctuations (i.e., foreign exchange “pass through” occurs) and how
frequently they do so determines the resilience of exporting firms against the exchange rate fluctuations. If
products are sufficiently competitive to revise their prices to maintain their constant earnings in terms of the
Japanese yen, then foreign exchange fluctuations can cause no long-term impact on their profit performance. Since
the RIETI 2009 survey was conducted following a sharp yen appreciation, a question on the price revision in
recent months reveals the firms’ response to yen appreciation. An expected result is that firms with yen invoicing
tended not to change export prices, while firms with dollar invoicing tended to have made price revisions.
3. Questionnaire survey – the case of Japanese exporters’ risk management

In this section, we summarize the stylized facts of 2009 RIETI Survey related to Japanese firms' exchange rate risk
management7. To elucidate their features, we classify our results by the firm size. Regarding the size, we set two
different measures, firm size and the foreign sales ratio. The former is a category based on total consolidated sales
immediately before the survey (mostly as of March 2009) that splits all listed manufacturers into three categories
consisting of large (upper 1/3), medium (middle 1/3), and small (lower 1/3). The latter is also a category based on
foreign sales ratio (total foreign sales/total consolidated sales) splitting all listed manufacturers into high (upper
1/3), medium (middle 1/3), and low (lower 1/3).
3.1. Share of currency invoicing in Japanese exports to the World

Table 3.1 presents the results of questionnaires upon the invoicing choice of Japanese firms' exports to the world,
where a simple arithmetic average of the invoicing share is reported. First, in all manufacturing industries, where
217 firms responded, yen-invoicing share is the largest (48.2%) followed by US dollar invoicing share (42.2%).
Euro invoicing share accounts for only 7.1%, and other currency invoicing share is very low (2.5%). Second, across
the firm size, the smaller the firm size, the higher the yen-invoicing share. In contrast, the larger the firm size, the
higher the US dollar invoicing share. In terms of the foreign sales ratio, however, no clear pattern of the invoicing
choice is observed.
Table 3.1. Currency invoicing share in exports from Japan to the World (by firm category, %).
Firm catogry All Total consolidated sales Total foreign sales/Total consolidated
sales
Large Medium Small High (upper Medium Low (lower

(upper 1/3) (middle 1/3) (lower 1/3) 1/3) (middle 1/3) 1/3)
# of responded (217) (80) (70) (67) (64) (70) (83)

firms
JPY 48.2 38.1 50.0 58.3 41.2 52.2 50.2
USD 42.2 47.8 41.7 35.8 45.5 39.0 42.0
Euro 7.1 10.5 5.1 5.2 11.0 5.7 5.3
Other 2.5 3.6 3.2 0.7 2.3 3.0 2.5

currencies
Result 1: The yen and the US dollar are mainly used in Japanese total exports to the world. The
smaller (larger) the firm size, the higher the yen (US dollar) invoicing share.
3.2. Financial and operational hedging

Regarding financial hedging through the foreign exchange market, Table 3.2 shows that 76.5% of firms use hedging
instruments of some kind through the foreign exchange market. Specifically, among the firms who use hedging
instruments, using “Forward” is the highest ratio (95.2%) followed by “Currency Option” (24.1%), and “Other
currency derivatives” (3.0%). Across the firm size, the ratio of using some kind of currency hedging instruments
increases monotonously as a firm size becomes greater. In addition, the ratio of using “Forward” and “Currency
Option” tends to become higher as a firm size becomes larger.
Table 3.2. Instruments of currency hedging through exchange rate markets (by firm category).
Firm All Total consolidated sales Total foreign sales/Total

category consolidated sales
Large Medium Small High Medium Low

(upper (middle (lower (upper (middle (lower
1/3) 1/3) 1/3) 1/3) 1/3) 1/3)
# of 217 86 73 68 69 71 87
reponded
firms (A)
Firms to answer using any # of 166 79 51 36 58 51 57

instrument of currency answers (B)
hedging
(B)/(A)(%) 76.5 91.9 69.9 52.9 84.1 71.8 65.5
Forward # of answer 158 79 47 32 55 49 54

“yes” (C)
(C)/(B)(%) 95.2 100.0 92.2 88.9 94.8 96.1 94.7
Currency option # of answer 40 27 6 7 23 8 9

“yes” (D)


1/3) 1/3) 1/3) 1/3) 1/3) 1/3)
(D)/(B)(%) 24.1 34.2 11.8 19.4 39.7 15.7 15.8
Other currency derivatives # of answer 5 2 2 1 1 2 2

“yes” (E)
(E)/(B)(%) 3.0 2.5 3.9 2.8 1.7 3.9 3.5
Note: Multiple answer is allowed for selecting financial hedging instruments.
Result 2: Around three quarters of Japanese firms use some foreign exchange hedging
instruments through the foreign exchange market. Firms with large consolidated sales or large
foreign sales actively use currency hedging instruments through foreign exchange markets.
Next, Table 3.3 presents answers related to performing “marry and netting” for what kind of foreign currency and
for what kind of transaction by industry type. Among 222 responded firms, 40.1% of firms use “marry and netting”.
Regarding the target currency for marry and netting, the U.S. dollar is the highest (97.8%) followed by the euro
(41.6%). Furthermore, marry and netting is used mainly for trade between the head office and subsidiaries
(85.4%). Across the firm size, the share of firms using “marry and netting” increases monotonously as the total
consolidated sales increase and the degree of the exposure to the overseas markets becomes greater.
Table 3.3. Do you use marry and/or netting as a means of exchange rate risk managements? (by firm category).


1/3) 1/3) 1/3) 1/3) 1/3) 1/3)
Firms to answer whether they # of 222 85 71 66 67 71 84

conduct marry and/or netting reponded
firms (A)
1. Yes, we do. # of 89 49 23 17 45 22 22
answers
(B)
(B)/(A)(%) 40.1 57.6 32.4 25.8 67.2 31.0 26.2
For what kind US dollar # of 87 47 23 17 44 21 22

of currency? answers
(C)
(C)/(B)(%) 97.8 95.9 100.0 100.0 97.8 95.5 100.0
Euro # of 37 25 8 4 22 6 9
answers
(D)
(D)/(B)(%) 41.6 51.0 34.8 23.5 48.9 27.3 40.9


1/3) 1/3) 1/3) 1/3) 1/3) 1/3)
Other currencies # of 8 8 0 0 4 2 2
answers
(E)
(E)/(B)(%) 9.0 16.3 0.0 0.0 8.9 9.1 9.1
For what kind Trade between head # of 76 40 22 14 40 19 17

of office and answers
transaction? subsidiaries (F)
(F)/(B)(%) 85.4 81.6 95.7 82.4 88.9 86.4 77.3
Others # of 15 12 0 3 7 3 5
answers
(G)
(G)/(B)(%) 16.9 24.5 0.0 17.6 15.6 13.6 22.7
2. No, we # of 133 36 48 49 22 49 62
don't. answers
(H)
(H)/(A)(%) 59.9 42.4 67.6 74.2 32.8 69.0 73.8
Note: Multiple answer is allowed for selecting currencies and transactions.
Result 3: Around 40% of Japanese firms use “marry and netting”. Larger firms or firms with
higher foreign sales share are more likely to use “marry and netting”.
3.3. Pass-through of the exchange rate fluctuation to the export price

Exchange rate pass through to the export price is one interesting topic related to the choice of invoicing currency.
We ask whether firms execute a pass-through exchange rate fluctuation to the export price, and how often they do
so. Table 3.4 summarizes the results. Among 215 firms responded, the share of firms that choose “It depends on
the circumstances and management decision” is the highest (51.2%) followed by “No, we only slightly pass through
to the export price” (32.1%). It is surprising that only 16.7% of firms have an internal rule to pass through the
exchange rate fluctuation to the export price. These results suggest that Japanese exporters cannot change their
export price easily even if there was a large fluctuation of foreign exchange rate. Sorting by the firm size measured
by total consolidated sales, the share of firms that have an internal price revision rule increases monotonously as
the total consolidated sales become larger. Furthermore; sorting by the foreign sales share, the firms that hardly
pass through the exchange rate fluctuation to the export price increases as the ratio of total foreign sales to total
consolidated sale becomes lower.
Table 3.4. Is there an internal rule to pass through the exchange rate fluctuation to the export price? (by firm
category).

Firm All Large Medium sales

Total consolidated Small High Medium
Total foreign Low
sales/Total
category (upper (middle (lower (upper (middle
consolidated sales (lower
1/3) 1/3) 1/3) 1/3) 1/3) 1/3)
# of 215 80
Large 69
Medium 66
Small 65
High 68
Medium 82
Low
reponded (upper (middle (lower (upper (middle (lower
firms (A) 1/3) 1/3) 1/3) 1/3) 1/3) 1/3)
1. Yes, there is a rule. # of 36 18 10 8 17 4 15

answers (B)
(B)/(A)(%) 16.7 22.5 14.5 12.1 26.2 5.9 18.3
2 No, we hardly pass through to # of 69 20 31 18 18 22 29

the export price. answers (C)
(C)/(A)(%) 32.1 25.0 44.9 27.3 27.7 32.4 35.4
3. It depends on the # of 110 42 28 40 30 42 38

circumstances and maangement answers
decisions. (D)
(D)/(A)(%) 51.16 52.5 40.6 60.6 46.2 61.8 46.3
3.3.1. Appreciation of the Japanese yen in 2008

We now turn the second question of whether firms passed through at substantial yen appreciation in 2008 to the
export price. Table 3.5 presents a summary of the results by type of industry. Among 209 firms responded, the
share of firms that passed through the exchange rate fluctuation to the export price in 2008 is 43.1%, which is
smaller than the negative answer (56.9%). A surprising result is that more than half of Japanese firms did not pass
through even in circumstances where the Japanese yen appreciated approximately 20% against the US dollar.
Regarding the target currency of the price revision (multiple answers allowed), the share of the U.S. dollar is the
highest (84.4%) followed by the euro (47.8%). Sorting by the firm size, the share of firms that pass through
increases monotonously as the firm size becomes larger.
Table 3.5. Did you pass through subtantial appreciation of Japanese yen in 2008 to the export price? (by firm
category).


1/3) 1/3) 1/3) 1/3) 1/3) 1/3)
# of 209 77 67 65 62 67 80
responded
firms (A)
1. Yes, we did. # of answers 90 41 25 24 32 28 30

(B)
(B)/(A)(%) 43.1 53.2 37.3 36.9 51.6 41.8 37.5
For what kind US dollar # of answers 76 35 21 20 30 22 24

of currency? (C)


1/3) 1/3) 1/3) 1/3) 1/3) 1/3)
(C)/(B)(%) 84.4 85.4 84.0 83.3 93.8 78.6 80.0
Euro # of answers 43 27 7 9 18 14 11
(D)
(D)/(B)(%) 47.8 65.9 28.0 37.5 56.3 50.0 36.7
Other # of answers 14 8 3 3 5 5 4
currencies (E)
(E)/(B)(%) 15.6 19.5 12.0 12.5 15.6 17.9 13.3
2. No, we didn't. # of answers 119 36 42 41 30 39 50

(F)
(F)/(A)(%) 56.9 46.8 62.7 63.1 48.4 58.2 62.5
Note: Multiple answer is allowed for selecting currencies.
Result 4: Many Japanese firms do not pass through the exchange rate fluctuation to their export
price. Larger firms or firms with higher foreign sales share are more likely to pass it through.
4. Estimating Japanese firms' exchange rate exposure

Many researchers have empirically investigated the exchange rate exposure of firms. Most of them measure the
exposure as the sensitivity of firm's value to exchange rate fluctuations. Because the value of the firm is the
discounted present value of its future cash flow streams, expectations of business environments including the
exchange rate changes are regarded to influence the present firm value. Many empirical studies have used stock
price returns as a proxy for the change in the value of the firm, and we follow that tradition. The exchange rate
exposure is measured as the coefficient of the exchange rate changes in the regression of stock price returns.
Traditionally, most Japanese firms have adopted various exchange rate risk management tools because of their
high share of US dollar invoicing and a trend of yen appreciation. Several previous studies have specifically
examined Japanese firms. Dominguez (1998), examined the exchange rate exposure of the Japanese main
industries during the period 1984–1995 and found that many Japanese companies are exposed to yen–dollar
exchange rate movements. Their results imply that they do not fully hedge against exchange rate risk. He and
Ng (1998), investigated a sample of 171 Japanese multinational firms’ stock price returns for the period of January
1979 – December 1993 and found that the exchange rate exposure increases with the firm's export ratio and
decreases with the level of hedging activity.8 Doukas et al. (2003), examined the exchange rate exposure for 1079
firms traded on the Tokyo stock exchange during the period 1975–1995 and confirmed that the exchange rate
exposure is found to be positively associated with the degree of the firm's foreign business activities and that it is
inversely related to its size and debt-to-asset ratio.
Among the models of previous studies, the simplest model is that of Adler and Dumas (1984), who define the
exchange rate exposure as the change in the market value of the firm resulting from a unit change in the exchange
rate. According to them, the exchange rate exposure of the firm is obtainable from the coefficient on the exchange
rate variable as follows.
ɛ (1)
where Ri,t is the stock price return for firm i, ∆st is the percentage change in an exchange rate variable, defined as
the home currency price of foreign currency, and β1,i is the elasticity of firm value to the exchange rate change. This
elasticity indicates the firm's average exchange rate exposure over the estimation period, in home currency units,
as a percentage of the firm's market value.
To control for other macroeconomic factors on realized returns, most empirical studies include a return to a
market portfolio in the regression model. For example, Dominguez and Tesar (2006), and many other related
studies estimate controlling for macroeconomic factors using market portfolio as follows:
ɛ (2)
where Rm,t is the return on the market portfolio and γ1,i is the elasticity of firm value to the exchange rate change
adjusted by the firm's market portfolio9.
Although most studies choose a regression model (2) to estimate Japanese firms' exchange rate exposure, with the
Tokyo Stock Price Index (TOPIX) being a market portfolio, two problems exist in model (2). First, because TOPIX
is correlated strongly with the dollar/yen rate, the two-factor regression model has a multicollinearity problem.
Second, Bodnar and Wong (2003), warned that the market portfolio variable strongly influences the results, and
that it sometimes put a downward bias on the coefficient and lowers the significance level.10 In the paper, we
estimate the sampled firms' exchange rate exposure using two different models above on a monthly basis.
Following Bodnar and Wong (2003), we refer to β1,i as the total exchange rate exposure and γ1,i as the residual
exchange rate exposure.
The treatment of exchange rate differs across the previous studies. For the exchange rate measure, we alternatively
use the nominal exchange rate (Japanese yen per US$, or USD/JPY in the currency pair code name) and nominal
effective exchange rate (NEER) published by BIS. Since an increase in the number of USD/JPY is yen depreciation,
while an increase in the number of NEER (defined by BIS) is yen appreciation, we define the percentage change of
BIS with an opposite sign. Hence, in both cases, an expected sign of β and γ are positive. For a market portfolio, we
alternatively use TOPIX and MSCI Japan Index.11,12 where the latter may be better than the former, as the TOPIX
is correlated strongly with the nominal exchange rate of the Japanese yen per US$ (USD/JPY), causing the
downward bias of the key coefficient.
The sample period for regressions is from January 2005 to December 2009. All but 2 of the estimated coefficients
have expected signs and two coefficients with the wrong sign are statistically insignificant for both the USD/JPY
regression and the NEER regression.13
Fig. 2 shows the estimated total exchange rate exposure using the yen/dollar exchange rate and NEER by BIS. On
average, their size is larger than 100% except for “Food” and “Medicinal Chemicals.” Among the fifteen industries,
the total exchange rate exposure of “Transport Equipment” is the highest and above 200%. This result indicates
that the exchange rate risk of “Transport Equipment” industries is larger than other industries and their stock price
return is affected more than twice of exchange rate change. Except for “Coal and Oil Products,” the exchange rate
exposures estimated by NEER are higher than those of the yen/dollar exchange rate. This result suggests that most
Japanese industries face not only the fluctuation risk of the yen/dollar exchange rate, but also other trade
countries’ exchange rates.
Fig. 2. Total exchange rate exposure by industry (monthly, January 2005 to December 2009).
Source: All stock price data for 227 responded firms are from Toyo Keizai KABUKA CD-ROM 2010. The Yen/USD
exchange rate is from Datastream. NEER is from BIS.
Fig. 3 presents the estimated residual exchange rate exposures using the yen/dollar exchange rate and NEER. All
are less than 100% and are smaller than the total exchange rate exposure. Similar to the previous case, the residual
exchange rate exposure of “Transport Equipment” is the highest among 15 industries. The second is “Precision
Instruments,” followed by “Electric Machinery” and “General Machinery” except for “Other Products.” These
results are consistent with the fact that such Japanese representative manufacturing industries are facing severe
competition with other countries.
Fig. 3. Residual exchange rate exposure by industry (monthly, January 2005 to December 2009).
Source: All stock price data for 227 responded firms are from Toyo Keizai KABUKA CD-ROM 2010. The Yen/USD
exchange rate is from Datastream. NEER is from BIS.
Contrary to the findings of the preceding figure, results of the size of two residual exchange rate exposures differ by
industry. First, the residual exchange rate exposures estimated by NEER are larger than those of yen/dollar
exchange rate in “Food,” “Medicinal Chemicals,” “Iron and Steel,” “Metal Products,” “General Machinery,”
“Electric Machinery,” “Transport Equipment,” “Precision Instruments,” and “Other Products.” Second, it is
particularly interesting that the residual exchange rate exposures estimated by the yen/dollar exchange rate are
greater than those of NEER in more basic material industries such as “Coal and Oil Products,” “Glass and Stone,”
and “Non Metal Products.” It is because the latter materials or products are predominantly invoiced in the US
dollar, while the former products tend to be invoiced in a number of currencies. The estimated results controlled
by TOPIX are mostly similar to those by the MSCI Japan index.
5. Determinants of firms' foreign exchange exposure

In this section, we investigate the relationship between the estimated exchange rate exposure and exchange rate
risk management of Japanese firms based on the questionnaire survey. As we presented in Section 3, the RIETI
Survey 2009 covers rich information related not only to the firms' foreign exchange rate risk management but also
to the firms' choice of invoicing currency and price revision (pass-through) strategy14. The survey results are
classified by industry and by firm size, using annual financial reports of sample firms, through which new evidence
of Japanese firms' exchange rate risk management, such as the usage of financial and operational hedging and
price revision, are presented.
Our hypotheses with respect to firms’ exchange rate risk management are as follows:
1. A large share of foreign sales to total sales increases the exchange rate exposure.
2. A high share of US$ invoicing increases the exchange rate exposure.
3. More financial and operational hedges reduce the exchange rate exposure.
4. More financial and operational hedges can be effective in reducing the exchange rate exposure, especially for a
firm that chooses mainly US$ invoicing.
5. A high share of yen invoicing decreases the exchange rate exposure.
6. A frequent price revision to achieve pass through decreases the exchange rate exposure.
Table 5.1. Relation between Exchange Rate Exposure, Exchange Rate Risk Management and US dollar invoicing.
Method: Least squares with white heteroskedasticity-consistent standard errors & covariance
Dependent variable Total exchange rate exposure Residual exchange rate exposure
nominal exchange NEER nominal nominal NEER, T

rate of yen/dollar exchange rate of exchange rate of
yen/dollar, yen/dollar,
TOPIX MSCIJapan
(1) (2) (3) (4) (5) (6) (7) (8) (9)
Constant 0.1802 0.2324 0.4540 0.5756 0.4845** 0.5428** 0.5127** 0.5707** 0.4232*
(0.1458) (0.1343) (0.3997) (0.3951) (0.2279) (0.2356) (0.2259) (0.2328) (0.2266)
Log of total 0.5386*** 0.5344*** 0.0415 0.0385 −0.0284 −0.0276 −0.0296 −0.0288 −0.0290
consolidated sales
(0.1663) (0.1655) (0.0365) (0.0366) (0.0220) (0.0219) (0.0218) (0.0216) (0.0221)
Share of foreign sales 0.6389*** 0.6307*** 0.9806*** 0.9846*** 0.4951** 0.4814*** 0.4571** 0.4423** 0.4024*
(0.1611) (0.1604) (0.2966) (0.2984) (0.1964) (0.1780) (0.1983) (0.1758) (0.2305)
Share of USD invoicing 0.5706*** 0.6140* 0.2767 0.2877 0.4200**
(0.2408) (0.3114) (0.1826) (0.1822) (0.1549)
USD main invoicing 0.4469** 0.3424 0.0839 0.0942 0.2308*
(0.1853) (0.2421) (0.1444) (0.1426) (0.1177)
Operational hedge 0.0074 0.0316 −0.0375 −0.0010 0.0302 0.0159 0.0112 0.0088 0.1842
(0.1582) (0.1125) (0.2074) (0.1493) (0.1168) (0.0891) (0.1146) (0.0880) (0.1530)
Financial hedge 0.1917 0.1185 0.3774** 0.2229 0.0159 0.0373 0.0130 0.0335 0.2731**
(0.1372) (0.1098) (0.1782) (0.1437) (0.0960) (0.0857) (0.0960) (0.0846) (0.1092)
Dependent variable Total exchange rate exposure Residual exchange rate exposure
nominal exchange NEER nominal nominal NEER, T

rate of yen/dollar exchange rate of exchange rate of
yen/dollar, yen/dollar,
TOPIX MSCIJapan
(1) (2) (3) (4) (5) (6) (7) (8) (9)
Pass-through −0.0952 −0.0837 −0.1103 −0.1010 0.0374 0.0424 0.0289 0.0356 0.0242
(0.0848) (0.0838) (0.1101) (0.1098) (0.0665) (0.0655) (0.0661) (0.0647) (0.0703)
ShareUSD*Operational −0.2080 0.0536 −0.2871 −0.2502 −0.4039*

hedge
(0.2790) (0.3602) (0.2188) (0.2158) (0.2306)
ShareUSD*financial −0.3924 −0.8274** 0.0639 0.0524 −0.4371*

hedge
(0.2724) (0.3551) (0.2123) (0.2115) (0.1998)
USD Main*Operational −0.3041* 0.0130 −0.2320* −0.2159 −0.2457*

hedge
(0.1755) (0.2296) (0.1369) (0.1353) (0.1499)
USD Main*Financial −0.2021 −0.4685* 0.0868 0.0776 −0.2095

hedge
(0.1951) (0.2574) (0.1535) (0.1517) (0.1434)
Industry dummy ○ ○ ○ ○ ○ ○ ○ ○ ○
Adjusted R-squared 0.3095 0.3147 0.1786 0.1672 0.0775 0.0639 0.0694 0.0528 0.1044
1) The number of observations is 183.
2) Estimated coefficient and standard error (in parentheses) are reported in each column.
3) Asterisk(s), ***, **, and * means that the estimated coefficients are statistically significant at less than 1%, 5%, and 10%,
respectively.
Table 5.2. Relation between exchange rate exposure, exchange rate risk management and yen invoicing.
Method: Least squares with white heteroskedasticity-consistent standard errors & covariance
Dependent Residual exchange rate exposure

Variable
nominal exchange rate nominal exchange rate of NEER, TOPIX NEER, MSCIJapan
of yen/dollar, TOPIX yen/dollar, MSCIJapan
(1) (2) (4) (5) (6) (7) (8) (9)
Constant 0.7122*** 0.7473*** 0.7630*** 0.7959*** 0.6100** 0.5755** 0.6588*** 0.6337***
(0.2391) (0.2324) (0.2353) (0.2293) (0.2396) (0.2347) (0.2432) (0.2368)
Dependent Residual exchange rate exposure

Variable
nominal exchange rate nominal exchange rate of NEER, TOPIX NEER, MSCIJapan
of yen/dollar, TOPIX yen/dollar, MSCIJapan
(1) (2) (4) (5) (6) (7) (8) (9)
Log of total −0.0287 −0.0312 −0.0307 −0.0333 −0.0320 −0.0310 −0.0347 −0.0341
consolidated
sales
(0.0212) (0.0212) (0.0210) (0.0209) (0.0217) (0.0218) (0.0219) (0.0220)
Share of foreign 0.4971** 0.4779** 0.4599** 0.4390** 0.4275* 0.4242* 0.4467* 0.4425*
sales
(0.1983) (0.1926) (0.1997) (0.1936) (0.2272) (0.2263) (0.2300) (0.2286)
Share of Yen −0.2020* −0.2206** −0.0415 −0.0481

invoicing
(0.1130) (0.1107) (0.1258) (0.1265)
Yen main −0.2062*** −0.2202*** −0.0042 −0.0185

invoicing
(0.0769) (0.0755) (0.0900) (0.0901)
Operational −0.1057 −0.1252 −0.1083 −0.1281* −0.0046 0.0030 −0.0113 −0.0067

hedge
(0.0793) (0.0763) (0.0778) (0.0746) (0.0958) (0.0927) (0.0969) (0.0939)
Financial hedge 0.0408 0.0340 0.0330 0.0264 0.1147 0.1192 0.0944 0.0975
(0.0701) (0.0703) (0.0690) (0.0691) (0.0844) (0.0843) (0.0855) (0.0854)
Pass-through 0.0187 0.0083 0.0112 0.0005 0.0137 0.0162 0.0075 0.0087
(0.0673) (0.0665) (0.0670) (0.0662) (0.0730) (0.0741) (0.0737) (0.0747)
Industry dummy ○ ○ ○ ○ ○ ○ ○ ○
Adjusted R- 0.0788 0.1031 0.0736 0.1012 0.0796 0.0789 0.0755 0.0748

squared
1) The number of observations is 189.
2) Estimated coefficient and standard error (in parentheses) are reported in each column.
3) Asterisk(s), ***, **, and * means that the estimated coefficients are statistically significant at less than 1%, 5%, and 10%,
respectively.
Hypotheses 1 and 2 have been examined in many previous studies. For example, Shapiro (1975) and Jorion (1990),
confirmed that a firm's currency exposure should be positively related to the ratio of foreign sales to total sales, and
the use of foreign currency hedging should lessen a firm's foreign exchange rate exposure. Hypothesis 3 has been
also tested in many previous studies. For example, Bartram et al. (2010), demonstrate that financial hedging with
foreign currency-denominated debt appears to have a larger effect on exposure than the use of foreign exchange
derivatives. Our contribution and novelty are in testing Hypotheses 4 and 5, which examine the effectiveness of
financial and operational hedge with the choice of invoicing currency.
As a dependent variable, we use the estimated exchange rate exposures in Section 4 as follows:
Total,JPY/USDi Total,NEERi
• β ,β : Firm i’s total exchange rate exposure obtained using nominal exchange rate of
yen/dollar and NEER, respectively;
• βResidualT,JPY/USDi, βResidualT,NEERi : Firm i’s residual exchange rate exposure obtained by TOPIX with nominal
exchange rate of yen/dollar and NEER, respectively;
• βResidualM,JPY/USDi, βResidualM,NEERi : Firm i’s residual exchange rate exposure obtained by MSCI Japan Index with
nominal exchange rate of yen/dollar and NEER, respectively.
As the basic explanatory variables in the right-hand side, we first include a “size” of firm i, measured by the log of
total consolidated sales, and “share of foreign sales” measured by total foreign sales of firms i divided by total
consolidated sales. Additionally, we use each firm's share of US dollar invoicing, i.e., the firm's answer in the RIETI
2009 Survey and four dummy variables: A dummy variable for using marry/netting (Dummy of OH) takes 1 if a
firm uses marry/netting and 0 if not. A dummy variable for using forward transaction (Dummy of FH) takes 1 if a
firm uses forward transaction and 0 if not. A dummy variable for executing price revision in 2008 (Dummy of PT)
takes 1 if a firm revised the price attributable to the sudden appreciation of the Japanese yen and 0 if not. As
another invoicing share variable, we also use a “dummy of USD Main Invoicing (yen Main Invoicing),” which takes
1 if the share of USD (yen) invoicing is larger than yen (USD) invoicing.15 First, we examine the determinants of
exchange rate exposure including the share of US dollar invoicing by using six kinds of estimated exchange rate
exposure as a dependent variable in the following regression model.
(3)
(4)
All estimated results are presented in Table 5.1. As expected, the coefficients of the share of foreign sales are
positive and statistically significant in all cases. The large share of foreign sales to total sales increases the exchange
rate exposure. The coefficients of share of USD invoicing and “USD main invoicing” in the regression are positive
and statistically significant in several cases, suggesting that once US-invoicing (or not yen-invoicing) is chosen, it is
very difficult to completely offset the exchange rate exposure by other mitigating measures, such as operational
and financial hedge. Contrary to our hypothesis 3, the coefficients of operational hedges and financial hedges are
not negative. Some of the coefficients of financial hedges are positive and statistically significant. In these cases,
the cross-term coefficients of financial hedges and USD invoicing (or USD main invoicing) are negative and
statistically significant in most cases. These results suggest that firms with a high US$ invoicing share can reduce
their exchange rate exposure using financial hedges. It is particularly interesting that the cross-term coefficients of
operational hedges and USD Main invoicing are negative and statistically significant in the exchange rate exposure
obtained by the yen/dollar exchange rate. The implication is that the exchange rate exposure obtained by the
yen/dollar exchange rate can be reduced by a combined strategy of USD main invoicing and “marry and netting”
strategy. Unfortunately, the coefficients of pass through are not significant.
Second, we examine the determinants of exchange rate exposure including the share of yen invoicing by using four
kinds of estimated exchange rate exposure as a dependent variable in the following regression model.
(5)
(6)
For an invoicing variable, we also use “Dummy of Yen Main Invoicing” in which the share of yen invoicing is larger
than that of USD invoicing.
Estimated results are presented in Table 5.2. As expected, the coefficients of both “share of yen invoicing” and “yen
main invoicing” are negative and significant in most cases. It is confirmed that the high share of yen invoicing
decreases the exchange rate exposure. In addition, any exchange rate risk management tools are not significant in
almost cases16.
In sum, Japanese firms' exchange rate exposure is found to be positively correlated to the share of foreign sales to
total sales. As expected, firms with higher ratios of US dollar invoicing have higher degrees of exchange rate
exposure as measured in the stock market. It is possible to mitigate the exchange rate exposure of the yen/dollar
exchange rate by engaging in operational hedging and that of the NEER by financial hedging. This result is
consistent with the conclusion of Ito et al., 2010a, Ito et al., 2012). Furthermore, firms with yen invoicing have a
lower exchange rate exposure measured in the stock market. Price revisions to make pass-through possible
theoretically reduces a firm's total exchange rate exposure, but it is not found to be statistically significant in the
regression.
6. Conclusion
This paper analyzed the relationship between the Japanese firms' exchange rate risk management based on the
2009 RIETI survey and the exchange rate risk exposures that are estimated as the sensitivity of stock price
movements to the exchange rate movement. Empirical results confirm the following characteristics. First, large
Japanese manufacturing industries have a significant exposure to exchange rate risk. Second, firms with greater
dependence on foreign sales have a larger foreign exchange exposure. Third, the higher the US dollar invoicing
ratio, the greater the foreign exchange exposure, but risk is reduced by financial and operational hedging. Fourth,
yen invoicing reduces the foreign exchange exposure. Theoretically, in the medium run, the firms with large
currency risk could revise their export prices to partially counter losses from yen appreciation. However, this was
not confirmed by the data.
Most of the results obtained above are consistent with conventional wisdom. However, it is a novel finding that
those firms employing currency hedges and choosing yen invoicing are judged by the market to have reduced
currency exposures. It is also found that Japanese firms who mainly choose US dollar invoicing do use operational
and financial hedging strategies effectively to reduce their exchange rate exposure. These results are obtained by
the exchange rate exposure estimated by stock returns. It means that the stock market is also effective to evaluate
firms’ exchange rate risk management by observing the relationship between firms’ cash flows and exchange rate
movements in the past.
This is the first detailed investigation of the exchange rate risk management policy of Japanese firms, which was
made possible by the newly conducted survey. These findings suggest important implications and tools for
Japanese firms' exchange rate risk managers to build more efficient risk management schemes.
The questionnaire method has well-known limitations as well as benefits. Supplementary sources such as firms'
financial reports are used to strengthen the analysis. For example, the listed firms’ exchange rate exposure is
estimated from their financial statements, and it is compared against their exposure and risk management from
the survey. In this paper, although we use only “marry and netting” as a proxy of operational hedges, firms have
more tools in their menu under operational hedges. For example, the firm level data such as foreign debt ratio,
R&D investment, volatility of (foreign) sales, and number of foreign subsidiary and production bases, play an
important role for their operational hedging. Further efforts will be necessary to obtain the above firm-level data,
which is left for future research.
Appendix A. Characteristic of 227 responded firms
Type of industry Number of Share of total Consolidated Foreign Foreign sales

responded responded Sales(Average, Sales(Average, share(Average)
firms firms million yen) million yen)
Foods 3 1.3% 483,825 227,374 32.3%
Textiles & 9 4.0% 102,142 17,585 23.2%

apparel
Pulp & papers 0 0.0% – –
Chemicals 36 15.9% 273,090 105,240 34.7%
Pharmaceuticals 3 1.3% 230,864 22,951 10.5%
Oil & coal 1 0.4% 3,428,211 399,070 11.6%

products
Rubber 4 1.8% 98,511 47,124 32.2%

products
Glass & 6 2.6% 55,315 25,978 30.3%

ceramics
Steel products 6 2.6% 882,765 298,665 23.4%
Nonferrous 5 2.2% 203,383 30,943 17.6%

metals
Metal products 9 4.0% 172,879 73,012 37.8%
Machinery 40 17.6% 158,355 89,751 35.7%
Electrical 54 23.8% 529,526 231,003 43.7%

machinery
Transport 27 11.9% 888,213 631,035 41.3%

equipment
Precision 15 6.6% 110,474 85,505 48.2%

instruments
Other products 9 4.0% 57,600 33,241 37.0%
Note: Questionnaires were sent to 920 Japanese firms listed on the stock exchanges in Japan. We selected the firms that reported
foreign sales in their consolidated financial statements as of fiscal year 2008, and 920 firms were finally chosen.
Appendix B. Descriptive statistics of all variables in Section 4
Basic information Hedge methodology Pass

through*
Log of total consolidate Foreign sales share Financial Operational

sale (%) hedge* hedge*
Mean 11.17 37.04 0.73 0.40 0.43
Median 10.98 35.10 1.00 0.00 0.00
Maximum 16.12 88.50 1.00 1.00 1.00
Minimum 5.06 6.80 0.00 0.00 0.00
Std. dev. 1.76 19.82 0.45 0.49 0.50
Observations 227 206 227 221 209
Choice of invoicing currency
INVOICE in USD (%) INVOICE in YEN (%) USD MAIN* YEN MAIN*
Mean 42.11 48.19 0.36 0.45
Median 40.00 50.00 0.00 0.00
Maximum 100.00 100.00 1.00 1.00
Minimum 0.00 0.00 0.00 0.00
Std. dev. 33.33 36.05 0.48 0.50
Observations 217 217 217 217
Total exchange rate Residual exchange rate exposure

exposure
yen/dollar NEER yen/dollar, yen/dollar, NEER, NEER,

TOPIX MSCIJapan TOPIX MSCIJapan
Mean 1.2370 1.7188 0.5220 0.5196 0.6115 0.6230
Median 1.1748 1.6519 0.4027 0.4091 0.5023 0.5037
Maximum 3.3893 4.9841 2.1892 2.2244 3.3997 3.2743
Minimum 0.0944 0.0192 0.0021 0.0114 0.0069 0.0008
Std. Dev. 0.6325 0.8091 0.4208 0.4130 0.5398 0.5374
Observations 227 227 227 227 227 227
Authors' calculation.
Note:
1. Financial Hedge is a dummy variable which takes 1 if a firm uses a forward transaction and takes 0 if not.
2. Operational Hedge is a dummy variable which takes 1 if a firm uses a marry & netting and takes 0 if not.
3. Pass through is a dummy variable which takes 1 if a firm changed a price due to the Yen's appreciation in 2008 and takes 0 if not.
4. USD MAIN is a dummy variable which takes 1 if the share of US dollar invoicing is higher than one of yen invoicing and takes 0 if
not.
5. YEN MAIN is a dummy variable which takes 1 if the share of Yen invoicing is higher than one of US dollar invoicing and takes 0 if
not.
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☆
The authors would appreciate the financial support of the JSPS (Japan Society for the Promotion of Science) Grant-in-Aid for
Scientific Research; Ito for (A) -25,245,044; Koibuchi for Young Scientists (B) No. 23730307Sato for (A) No. 24,243,041 and (B) No.
24,330,101, and Shimizu for (C) No. 24,530,362 and No. 15K03548. This survey is supported by the Research Institute of Economy,
Trade and Industry (RIETI) and the Ministry of Economy, Trade and Industry (METI). We wish to thank all respondents of firms and
RIETI staff for their kind help and cooperation.
1
Japanese exporting firms might not have to stabilize their profits in terms of the yen, if they become more globalized. Indeed,
Japanese major exporting firms tend to establish a large number of overseas production and sales subsidiaries, with large amounts
of foreign sales. However, such globalized firms account for a small share of Japanese total manufacturing firms in terms of the
number of firms. As discussed in Table 3.2 below, the firms whose size is medium or small in terms of consolidated sales or the ratio
of foreign sales to consolidated sales tend to choose not U.S. dollar invoicing but yen-invoicing. This evidence suggests that smaller
size firms tend to avoid foreign exchange risk and to stabilize their profits in terms of the yen. For global firms, yen depreciation
(appreciation) will increase (decrease) the amount of repatriation in terms of the yen, given a large amount of Japanese income
surplus in recent years. Thus, for Japanese firms, avoiding exchange rate risk and stabilizing their profits in the yen are still an
important business strategy.
2
Ito et al., 2010a, Ito et al., 2010b, Ito et al., 2012) investigate this puzzle by conducting and analyzing a series of interviews of
representative exporters.
3
For example, Carter, Pantzalis et al. (2001) investigate the impact of firmwide risk management practices for US multinational
corporations and find that currency risk can be reduced effectively through transactions in the forward exchange market.
4
They use a sample of 424 firm observations from the COMPUSTAT Geographic Segment files for 1998.
5
Regarding the relation between pass-through and hedging, Bartram et al. (2010) shows empirically that firms pass-through some
porting of currency changes to customers and use both operational and financial hedges for the rest of the foreign exchange
exposure.
6
Ito et al. (2010b) interviewed treasurers of 23 Japanese companies from four major export industries (automobile, electrical
machinery, general machinery, and electronic components) over the one-year period of autumn 2007 – autumn 2008.
7
Please refer Ito et al. (2010a) and Ito et al. (2013) the details of the 2009 RIETI Survey result.
8
In addition, they confirmed that keiretsu multinational corporations are more exposed to exchange-rate risk than non-keiretsu firms
are.
9
In addition to the local market portfolio, Parsley and Popper (2006) use the international market portfolio denominated in local
currency as well. Accordingly, their estimate results of exchange rate exposure of 100 Japanese firms on yen-dollar exchange rate
were smaller than ours.
10
Bodnar and Wong (2003) demonstrate that different constructions of a market portfolio have different exposures to exchange rates
because of significant size effects in exchange rate exposures. They propose the use of cap-based portfolios as controls for market
factors.
11
The MSCI Japan Index is a free-float adjusted market capitalization weighted index that is designed to track the equity market
performance of Japanese securities listed on Tokyo Stock Exchange, Osaka Stock Exchange, JASDAQ and Nagoya Stock
Exchange. The MSCI Japan Index (Price Index) is calculated in JPY on a real time basis.
12
For a robustness check, we try to use an international index (MSCI World Price Index) by calculating the return in terms of the
Japanese yen as a control variable, which is followed the suggestion of Dominguez and Tesar (2006). The estimated results are
almost equal to those of the MSCI Japan Index.
13
For these analyses, we use all estimated coefficients, either significant or not significant. Although some previous studies have
devoted attention to statistical significance. We might lose the case of small exchange rate exposure from our sample. For a
robustness check, we conduct the same analysis using statistically significant coefficients only. We confirm that we obtained similar
results.
14
In addition, trade pattern, such as intra-firm trade or inter-firm trade, also may affect the exchange rate exposure. For example, Ito
et al. (2012) use the ownership ratio or the equity participation as the proxy of intra-firm trade and confirm that the higher the
ownership ratio or the equity participation ratio of overseas subsidiaries, the larger the foreign exchange risk is undertaken by the
head office. In the present research, we included the “operational hedge” variable as an explanatory variable to examine the effect of
hedging strategy on exchange rate exposure, while operational hedge may have been correlated with intra-firm trade. Accordingly,
we can roughly distinguish between intra-firm trade and inter-firm trade by using the above information.
15
Descriptive statistics of all variables are presented in the Appendix B.
16
We tried to use the cross-term coefficients of financial/operational hedges and share of Yen invoicing (or Yen main invoicing) similar
to the USD invoicing analyses, however, they were not statistically significant, and so we did not include these results in the table.
© 2016 Elsevier Inc. All rights reserved.
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2. Exchange rate risk management of Japanese firms

2.1. Variety of exchange rate risk management

2.2. Japanese firms' feature of currency invoicing and pass through

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Fig. 1. Concept of exchange rate risk management.

2.3. Effectiveness of the Japanese firms' exchange rate risk management

2.3.1. Choice of invoicing currency

2.3.2. With an operational hedge (“marry and netting”)

2.3.3. Degree of financial hedge (hedging ratio of forward contract)

2.3.4. Exchange rate pass through

3. Questionnaire survey – the case of Japanese exporters’ risk management

3.1. Share of currency invoicing in Japanese exports to the World

Large Medium Small High (upper Medium Low (lower

# of responded (217) (80) (70) (67) (64) (70) (83)

JPY 48.2 38.1 50.0 58.3 41.2 52.2 50.2

USD 42.2 47.8 41.7 35.8 45.5 39.0 42.0

Euro 7.1 10.5 5.1 5.2 11.0 5.7 5.3

Other 2.5 3.6 3.2 0.7 2.3 3.0 2.5

3.2. Financial and operational hedging

Firm All Total consolidated sales Total foreign sales/Total

Large Medium Small High Medium Low

Firms to answer using any # of 166 79 51 36 58 51 57

(B)/(A)(%) 76.5 91.9 69.9 52.9 84.1 71.8 65.5

Forward # of answer 158 79 47 32 55 49 54

(C)/(B)(%) 95.2 100.0 92.2 88.9 94.8 96.1 94.7

Currency option # of answer 40 27 6 7 23 8 9

Firm All Total consolidated sales Total foreign sales/Total

Large Medium Small High Medium Low

(D)/(B)(%) 24.1 34.2 11.8 19.4 39.7 15.7 15.8

Other currency derivatives # of answer 5 2 2 1 1 2 2

(E)/(B)(%) 3.0 2.5 3.9 2.8 1.7 3.9 3.5

Note: Multiple answer is allowed for selecting financial hedging instruments.

Firm All Total consolidated sales Total foreign sales/Total

Large Medium Small High Medium Low

Firms to answer whether they # of 222 85 71 66 67 71 84

(B)/(A)(%) 40.1 57.6 32.4 25.8 67.2 31.0 26.2

For what kind US dollar # of 87 47 23 17 44 21 22

(C)/(B)(%) 97.8 95.9 100.0 100.0 97.8 95.5 100.0

(D)/(B)(%) 41.6 51.0 34.8 23.5 48.9 27.3 40.9

Firm All Total consolidated sales Total foreign sales/Total

Large Medium Small High Medium Low

(E)/(B)(%) 9.0 16.3 0.0 0.0 8.9 9.1 9.1

For what kind Trade between head # of 76 40 22 14 40 19 17

(F)/(B)(%) 85.4 81.6 95.7 82.4 88.9 86.4 77.3

(G)/(B)(%) 16.9 24.5 0.0 17.6 15.6 13.6 22.7

(H)/(A)(%) 59.9 42.4 67.6 74.2 32.8 69.0 73.8

Note: Multiple answer is allowed for selecting currencies and transactions.

3.3. Pass-through of the exchange rate fluctuation to the export price

Firm All Total consolidated sales Total foreign sales/Total

Firm All Large Medium sales

1. Yes, there is a rule. # of 36 18 10 8 17 4 15

(B)/(A)(%) 16.7 22.5 14.5 12.1 26.2 5.9 18.3

2 No, we hardly pass through to # of 69 20 31 18 18 22 29

(C)/(A)(%) 32.1 25.0 44.9 27.3 27.7 32.4 35.4

3. It depends on the # of 110 42 28 40 30 42 38

(D)/(A)(%) 51.16 52.5 40.6 60.6 46.2 61.8 46.3

3.3.1. Appreciation of the Japanese yen in 2008

Firm All Total consolidated sales Total foreign sales/Total

ShareUSDOperational −0.2080 0.0536 −0.2871 −0.2502 −0.4039

USD MainOperational −0.3041 0.0130 −0.2320* −0.2159 −0.2457*

USD MainFinancial −0.2021 −0.4685 0.0868 0.0776 −0.2095

Constant 0.7122* 0.7473* 0.7630* 0.7959* 0.6100 0.5755 0.6588* 0.6337*

Yen main −0.2062* −0.2202* −0.0042 −0.0185