Australian Foreign Currency Loans: Hedging or Arbitrage?
38 Pages Posted: 10 Dec 2013 Last revised: 7 Apr 2014
Date Written: March 30, 2013
Foreign currency denominated loans (FCDLs) are an important part of corporate funding as well as an operational risk management tool. We show that Australian borrowers use FCDLs to hedge their foreign exchange risk exposure. FCDLs are found to carry an interest rate premium over domestic currency loans after controlling for borrower characteristics, loan characteristics and macroeconomic conditions. We argue that borrowers are willing to pay this premium since the marginal benefit of FCDLs as a natural hedge outweighs the marginal cost. From a lender's perspective, this premium reflects a compensation for additional foreign exchange risk exposure and intensified monitoring efforts. These results are robust to endogeneity-corrected estimations.
Keywords: foreign currency denominated loans, hedging, interest rate arbitrage, currency choice, loan prices
JEL Classification: G21, G32
Suggested Citation: Suggested Citation