Is there a need for hedging exposure to foreign exchange risk?

Abstract

The performance of three strategies of hedging exposure to foreign exchange risk are evaluated in terms of the ability to optimize the domestic currency value of the exposure. The results, based on data covering the exchange rates of three currencies against the US dollar, reveal that hedging or no hedging will not make any difference over a long period of time even if perfectly accurate forecasts are available. This result is attributed to the validity of the unbiased efficiency hypothesis in the long run. It is argued that if the exposure is large and non-recurring then it should be hedged by using forward contracts in preference to money market hedging. To add more flexibility to the operation in situations like this, an option hedge may be considered.