Firms that buy or produce goods in one country and sell them in another are exposed to the potential of wild gyrations in exchange rates which can make it almost impossible to plan sales and production beyond six months ahead. While exchange risk hedging in a static (that is, one-period) setting is extremely straightforward, in a multi-period setting, the matter is much less simple. Information concerning a future cash flow evolves over time. For that reason, a hedge undertaken early on may have to be revised several times and these revisions themselves increase the level of risk.

The earlier that a hedging programme for a particular cash flow is initiated, the more numerous will be the future revisions, and the more cumbersome will be the hedging programme. In Discussion Paper No. 1083, Programme Director Bernard Dumas explores the case for deliberately leaving a cash flow unhedged for some time, initiating a hedge at some appropriate time and thereafter, perhaps, leaving the hedge untouched until the cash flow is received or paid. Accepting the idea that late hedging is preferable, provided the attendant increase in risk is negligible, he then argues that the decision to hedge early or late should depend on whether the cash flow to be hedged is correlated with changes in the exchange rate or with its level.

Short- and Long-term Hedging for the Corporation
Bernard Dumas