Third, how does the firm structure

Third, how does the firm structure the derivative portfolios used for foreign exchange risk management? Primarily because of accounting treatment and competitive pricing concerns, HDG has a strong preference for using options to structure its hedges. In fact, for some illiquid currencies for which options are less viable, HDG would rather not hedge at all than use forwards. The transaction-level data allow for the examination of cross-sectional and time-series variation in hedge ratios as well as statistical analysis of factors that impact hedging behavior. The results from statistical tests indicate that exchange rate volatility and exposure volatility are important determinants of optimal hedging policies. In addition, it appears managerial views and recent hedging history are also key factors.
All together, these results provide the most detailed examination of a firm’s foreign exchange hedging program to date. Still, there are general questions left unanswered. For example, how do the different, and possibly conflicting, risk management goals interact? How do differing goals determine the structure of the hedging strategy? And perhaps most importantly, how do we measure the overall economic impact of risk management? However, one thing is clear; the process of using derivatives to hedge foreign exchange risk at HDG is complex. The evidence indicates that multiple factors determine both why and how foreign exchange risk is managed. While some of these have been discussed in the academic literature, a contribution of this paper is to reveal in detail the mechanisms through which risk management may increase firm value. Hopefully, this will facilitate theoretical work that is consistent with industry practice and motivate knew empirical research with larger samples.