Currency Hedging: Managing Cash Flow Exposure
Foreign currency derivative markets are among the largest in the world, yet their role in emerging markets 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 2005, together with firm-level information on sales, international trade, trade credits and foreign currency debt. We uncover four novel facts: (i) natural hedging of currency risk is limited, (ii) financial 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 currency risk, and (iv) firms are more likely to pay higher premiums for longer maturity contracts. We then show that financial intermediaries can affect the forward exchange rate market through a liquidity channel, by leveraging a regulatory negative supply shock that reduced firms' use of FX derivatives and increased the forward premiums.
We thank José-Ignacio Cristi for outstanding research assistance. We thank comments by Maxim Alekseev, Pol Antràas, Paola Conconi, Dave Donaldson, Songuyan Ding, Alessio Galluzzi, Gordon Hanson, Victoria Ivashina, David Kohn, Robert Kollman, Philip Luck, Nicolas Magud, Ugo Panizza, José Luis Peydró, Hélène Rey, Adi Sunderam, and participants at BIS, ECARES, CEPR ESSIM IFM, Geneve Trade and Development Workshop, GW School of Business, Halle Institute, Harvard-MIT trade lunch, PUC-Chile, WEAI conference, 3rd Banking and Financial Stability Conference, 2020-ASSA and 2020-Winter Econometric Meetings for numerous comments and suggestions. We thank Alexander Hynes and Paulina Rodríguez for their help with the data. The opinions expressed in paper do not represent those of the Board of the Central Bank of Chile or the National Bureau of Economic Research.