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Pass-Through, Exposure, and the Currency Composition of Debt

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  • Michaux, Michael

    (University of Southern California)

Abstract

Using a dataset of traded Mexican firms, I document two stylized facts about firms in the non- tradable sector: (i) they take on large amounts of dollar-denominated debt and (ii) their earnings are not sensitive to the exchange rate. I propose an explanation based on imperfect competition in the domestic goods market that reconciles these seemingly contradictory empirical facts. First I develop a stylized model of production and financing for firms in an open economy. I show that non-exporting firms are exposed to exchange rate risk because of the presence of exporters in the economy, and that they hedge their currency exposure using dollar debt. An extended model is used to quantify how much of the dollar debt in the data can be explained through this channel. Counterfactual experiments are used to estimate the value of hedging using dollar debt. A calibrated version of the model can account for all of the dollar debt observed in the data and the value of hedging is estimated to be 28% of total firm value.

Suggested Citation

  • Michaux, Michael, 2010. "Pass-Through, Exposure, and the Currency Composition of Debt," Working Papers 10-3, University of Pennsylvania, Wharton School, Weiss Center.
    • Handle: RePEc:ecl:upafin:10-3
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    More about this item

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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