European Journal of Law and Economics

, Volume 34, Issue 2, pp 391–412 | Cite as

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



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.


Behavioral law and economics Foreign exchange forward contracts Knock-in knock-out contracts 

JEL Classification

K00 K22 



We thank Professor Richard R.W. Brooks of Yale Law School for sharing his invaluable insights. We also thank Professor Sangwon Suh and other seminar participants of the Institutions and National Competitiveness Conference, held in August 2009 in Seoul, Korea, for their helpful comments. Geary Choi and Joanne Koo provided excellent research assistance. David L. Simons provided superb editorial assistance. Ko’s research for this article was supported by the Law Research Institute at Seoul National University School of Law. This article was prepared while Moon was with the Center for International Economic & Business Law, Seoul National University.


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Copyright information

© Springer Science+Business Media, LLC 2010

Authors and Affiliations

  1. 1.Seoul National University School of LawSeoulKorea
  2. 2.Yale Law SchoolNew HavenUSA

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