FX Derivatives

Do non-financial firms simply hedge and hold, or do they actively manage their derivative positions over time in response to changing market conditions? We find clear evidence of the latter: Brazilian firms frequently adjust their positions as conditions shift, rather than passively maintaining a hedge tied to their operating exposure.

We then examine what drives these adjustments. Two forces appear to be at work: firms respond to the recent performance of their own derivative positions, consistent with the “house money effect” of Thaler and Johnson (1990), and to prevailing market pricing, timing their positions to take advantage of favorable currency-market conditions. Both forces are present, but the first dominates, suggesting an agency problem in corporate hedging. We also document that firms with opposite underlying currency exposures respond quite differently to the same market conditions. These patterns have direct implications for how shareholders, investors, and regulators should think about corporate hedging programs.