Increasing Derivatives Market Activity in Emerging Markets and Exchange Rate Exposure

Using firm level data, we report a significant fall in the exchange rate exposure of emerging market firms over the past 10 years, and relate this to higher derivatives market participation. Our methodology follows a three stage approach. First, we measure and report foreign exchange exposures for each year using the popularized extension of the Adler-Dumas (1984) model. Next, we use an indirect approach to estimate the derivatives market participation at the firm level. Finally, we investigate the implications of the level of derivative market activity on a firm's foreign exchange exposure. Our results show that foreign exchange exposure is negatively related to derivatives usage, and support the hedging explanation of the exchange rate exposure puzzle.