Institutional Investors and Foreign Exchange Risk
40 Pages Posted: 12 May 2011
Date Written: May 1, 2011
Financial institutions differ from individual investors both in their analytical ability and in their level of diversification. Their access to derivative markets is also superior compared to that enjoyed by individual investors. All these factors make institutional investors more capable of homemade hedging, and thus lead to an expectation that institutions are drawn to firms with higher foreign exchange risk. We observe institutional appetite for FX exposure and find variation among institution types. Institutions that are by their nature more likely to actively manage foreign exchange risk in their portfolio, namely mutual funds and hedge funds, follow our prediction and seek foreign exchange risk. Institutions that are constrained by regulation tend to avoid foreign exchange risk.
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