2020
Working Paper
HBS Working Paper Series

Currency Hedging in Emerging Markets: Managing Cash Flow Exposure

By: Laura Alfaro, Mauricio Calani and Liliana Varela

Format:Print
| Language:English
| Pages:54

Abstract

Foreign currency derivative markets are among the largest in the world, yet their role in emerging markets in particular, is relatively understudied. We study firms' currency risk exposure and their hedging choices by employing a unique dataset covering the universe of FX derivatives transactions in Chile since 2003, together with firm-level information on sales, international trade, trade credits, and debt. We uncover four stylized facts: (i) natural hedging of currency risk is limited, (ii) financial hedging is more likely to be used by larger firms, (iii) firms in international trade are more likely to use FX derivatives to hedge their gross (rather than net) cash currency risk, and (iv) firms are more likely to pay larger premiums for longer maturity contracts. We then use a policy reform to study the role of financial intermediaries in affecting the dynamics of the forward exchange rate markets. We show that a negative supply shock -reducing the liquidity of FX derivatives to firms-lowers firms use of FX derivatives and increases the forward premium.

Keywords

Foreign Currency Hedging; FX Derivatives; Foreign Currency Debt; Currency Mismatch; Trade Credit; Currency; Cash Flow; Emerging Markets

Citation

Alfaro, Laura, Mauricio Calani, and Liliana Varela. "Currency Hedging in Emerging Markets: Managing Cash Flow Exposure." Harvard Business School Working Paper, No. 21-096, March 2021.