Inflation and Interest Rate Derivatives for FX Risk Management : Implications for Exporting Firms under Real Wealth

Firms that export goods face risks such as product price, cost, and exchange rate risks. Price and cost risks can substantially reduce the FX hedging performance in real wealth. Thus, hedging strategies that are supposed to improve the performance of the FX hedge in real terms using inflation and interest rate derivatives are investigated. The behavior of these additional instruments is not obvious at first sight and has not been presented in the hedging literature so far. For this purpose, variance-minimizing hedge positions of an exporting firm are derived. A cointegrated VAR and bootstrap methods are used to evaluate the efficiencies of several hedging strategies. While inflation derivatives work better in the short run, interest rate derivatives perform better over longer hedge horizons