FX debt and optimal exchange rate hedging
Summary
Focus
We examine the extent to which large companies around the world borrow money in foreign currencies and whether they optimally hedge the risks that come with changes in exchange rates. We use detailed financial data from thousands of firms in both advanced and emerging market economies, from 2005 to 2023. We study how common foreign currency borrowing is and use a well-known risk management framework to test whether firms protect themselves against sudden movements in exchange rates.
Contribution
This research helps to explain how foreign currency debt affects companies and the wider economy. We challenge the common belief that borrowing in foreign currency is mainly a problem for emerging markets, showing that firms in advanced economies also use it frequently. By exploring how firms hedge their risks, the paper adds to our understanding of financial stability and the ways companies protect themselves from currency shocks. The findings are important for policymakers who want to understand and manage risks from FX debt.
Findings
Borrowing in foreign currency is widespread among large firms in both advanced and emerging market economies, but the level of use varies a lot from country to country. Most firms seem to manage their exchange rate risks well, offsetting risk from their foreign currency debt with income or assets in foreign currencies or with other aspects of their business. However, some firms – especially in emerging markets – remain exposed to large losses if their local currency suddenly falls in value against the US dollar. We also find that firms in emerging markets use foreign assets as a hedge, in addition to financial hedging, whereas firms in advanced economies rely less on this strategy than on financial hedging.
Abstract
This paper examines optimal foreign currency (FX) hedging by non-financial corporations globally. Using a cross-country, firm-level dataset, we first document key patterns of FX borrowing across advanced (AEs) and emerging market economies (EMEs). We find that while FX debt is prevalent in both groups, its intensity varies considerably. We assess the optimality of firms' exchange rate exposures using a risk-management framework where hedging serves to minimize the impact of cash flow volatility on firm value. Our results indicate that most firms hedge optimally, as exposures from FX debt are largely offset by other exposures, like foreign revenues and assets. While the distribution of exchange rate risk is broadly similar between AE and EME firms, the EME distribution has thicker tails, revealing a larger concentration of firms with significant, unhedged depreciation risk.
JEL classification: F31, F34, G30, G32
Keywords: foreign currency debt, currency risk, currency hedging
