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      Currency Hedging in Emerging Markets: Managing Cash Flow Exposure
      06 Apr 2021Working Paper Summaries

      Currency Hedging in Emerging Markets: Managing Cash Flow Exposure

      by Laura Alfaro, Mauricio Calani, and Liliana Varela
      Economies with less liquid foreign exchange derivative markets offer firms fewer options to hedge their currency risk. Given the limitations of natural hedging, these firms are more exposed to systemic risk.
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      Author 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.

      Paper Information

      • Full Working Paper Text
      • Working Paper Publication Date: March 2021
      • HBS Working Paper Number: 21-096
      • Faculty Unit(s): General Management
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      Laura Alfaro
      Laura Alfaro
      Warren Alpert Professor of Business Administration
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