Why Firms Use Currency Derivatives

TLDR

The study investigates how firms use currency derivatives to test competing hedging theories. It finds that firms with higher growth prospects, tighter financial constraints, larger foreign‑exchange exposure, and hedging economies of scale are more likely to use currency derivatives, and that the source of FX exposure influences the choice of derivative type.

Abstract

We examine firms' use of currency derivatives in order to differentiate among existing theories of hedging behavior. Firms with greater growth opportunities and tighter financial constraints are more likely to use currency derivatives. This result suggests that firms might use derivatives to reduce cash flow variation that might otherwise preclude firms from investing in valuable growth opportunities. Firms with extensive foreign exchange-rate exposure and economies of scale in hedging activities are also more likely to use currency derivatives. Finally, the source of foreign exchange-rate exposure is an important factor in the choice among types of currency derivatives.