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Empirical evidence on the incentives to hedge transaction and translation exposure


  • Niclas Hagelin

    (Stockholm University School of Business)

  • Bengt Pramborg

    (Stockholm University School of Business)


We investigate Swedish firms’ use of financial hedges to reduce their foreign exchange exposure for 1997–2001. The study uses survey data, which enables us to differentiate between hedging aimed at translation exposure and transaction exposure, respectively. The survey responses show that more than 50% of the firms employ financial hedges and that transaction exposure is more frequently hedged than translation exposure. We find that the likelihood of using financial hedges is increasing with firm size and exposure and that liquidity constraints are important in explaining transaction exposure hedging. Importantly, we find that the existence of loan covenants explains translation exposure hedging. This suggests that firms hedge translation exposure in order to prevent costly violations of loan covenants.

Suggested Citation

  • Niclas Hagelin & Bengt Pramborg, 2004. "Empirical evidence on the incentives to hedge transaction and translation exposure," Finance 0407020, EconWPA.
  • Handle: RePEc:wpa:wuwpfi:0407020
    Note: Type of Document - pdf; pages: 27

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    References listed on IDEAS

    1. Niclas Hagelin, 2003. "Why firms hedge with currency derivatives: an examination of transaction and translation exposure," Applied Financial Economics, Taylor & Francis Journals, vol. 13(1), pages 55-69.
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    3. Mian, Shehzad L., 1996. "Evidence on Corporate Hedging Policy," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 31(03), pages 419-439, September.
    4. Gerald D. Gay & Jouahn Nam, 1998. "The Underinvestment Problem and Corporate Derivatives Use," Financial Management, Financial Management Association, vol. 27(4), Winter.
    5. Cragg, John G, 1971. "Some Statistical Models for Limited Dependent Variables with Application to the Demand for Durable Goods," Econometrica, Econometric Society, vol. 39(5), pages 829-844, September.
    6. Leland, Hayne E, 1994. " Corporate Debt Value, Bond Covenants, and Optimal Capital Structure," Journal of Finance, American Finance Association, vol. 49(4), pages 1213-1252, September.
    7. Core, John E. & Schrand, Catherine M., 1999. "The effect of accounting-based debt covenants on equity valuation1," Journal of Accounting and Economics, Elsevier, vol. 27(1), pages 1-34, February.
    8. Roberts, Gordon S & Viscione, Jerry A, 1984. " The Impact of Seniority and Security Covenants on Bond Yields: A Note," Journal of Finance, American Finance Association, vol. 39(5), pages 1597-1602, December.
    9. John R. Graham & Daniel A. Rogers, 2002. "Do Firms Hedge in Response to Tax Incentives?," Journal of Finance, American Finance Association, vol. 57(2), pages 815-839, April.
    10. Smith, Clifford W. & Stulz, René M., 1985. "The Determinants of Firms' Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(04), pages 391-405, December.
    11. Froot, Kenneth A & Scharfstein, David S & Stein, Jeremy C, 1993. " Risk Management: Coordinating Corporate Investment and Financing Policies," Journal of Finance, American Finance Association, vol. 48(5), pages 1629-1658, December.
    12. John D. Knopf & Jouahn Nam & John H. Thornton Jr., 2002. "The Volatility and Price Sensitivities of Managerial Stock Option Portfolios and Corporate Hedging," Journal of Finance, American Finance Association, vol. 57(2), pages 801-813, April.
    13. Geczy, Christopher & Minton, Bernadette A & Schrand, Catherine, 1997. " Why Firms Use Currency Derivatives," Journal of Finance, American Finance Association, vol. 52(4), pages 1323-1354, September.
    14. Marston, Richard C., 2001. "The effects of industry structure on economic exposure," Journal of International Money and Finance, Elsevier, vol. 20(2), pages 149-164, April.
    15. Smith, Clifford Jr. & Warner, Jerold B., 1979. "On financial contracting : An analysis of bond covenants," Journal of Financial Economics, Elsevier, vol. 7(2), pages 117-161, June.
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    Cited by:

    1. Pramborg, Bengt, 2005. "Foreign exchange risk management by Swedish and Korean nonfinancial firms: A comparative survey," Pacific-Basin Finance Journal, Elsevier, vol. 13(3), pages 343-366, June.
    2. Hagelin, Niclas & Pramborg, Bengt, 2005. "Foreign exchange exposure, risk management, and quarterly earnings announcements," Journal of Multinational Financial Management, Elsevier, vol. 15(1), pages 15-30, February.

    More about this item


    Risk management; hedging; foreign exchange exposure; transaction exposure; translation exposure; loan covenants; bond covenants;

    JEL classification:

    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G39 - Financial Economics - - Corporate Finance and Governance - - - Other

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