Currency Hedging: Managing Cash Flow Exposure

By: Laura Alfaro, Mauricio Calani and Liliana Varela

Format:Print
| Language:English

Abstract

Foreign currency use can be a source of risk associated with currency mismatches, which firms can hedge using FX derivatives. This paper uncovers five novel facts about firms’ use of foreign currency (FX) derivatives employing a unique dataset covering the universe of FX derivatives transactions in Chile from 2005-2018, together with firm-level census data on employment, sales, international trade, trade credits, and foreign currency debt. (i) Natural hedging of currency risk is limited. (ii) FX hedging is more likely to be used by larger firms and for larger amounts. (iii) Firms in international trade are more likely to use FX derivatives to hedge their gross—not net—cash flow currency risk. (iv) The FX premium is heterogeneous across and within firms, higher for smaller firms and longer maturity contracts. (v) Macroeconomics conditions affect firms’ hedging policies, as changes in the liquidity of the FX market affect firms’ use. Our results indicate that financial constraints impact the use of FX derivatives, affecting how firms use these instruments to manage cash flow commitments.

Keywords

FX Derivatives; Hedging; Currency; Cash Flow; Emerging Markets; Chile

Citation

Alfaro, Laura, Mauricio Calani, and Liliana Varela. "Currency Hedging: Managing Cash Flow Exposure." NBER Working Paper Series, No. 28910, June 2021. (Revised July 2022.)