Cross-Hedging of Exchange Rate Risks: A Note

This note studies the optimal production and hedging decisions of a competitive international firm that exports to two foreign countries. The firm faces multiple sources of exchange rate uncertainty. Cross-hedging is plausible in that one of the two foreign countries has a currency forward market. We show that the firm’s optimal forward position is an overhedge, a full-hedge or an under-hedge, depending on whether the two random exchange rates are strongly positively correlated, uncorrelated or negatively correlated, respectively.