Using the dollar notional value of foreign currency derivatives has several advantages
over using a binary variable to indicate whether or not a firm uses foreign
currency derivatives. For example, by using this continuous variable, we can test
hypotheses on the determinants of the amount of hedging and examine the impact
of a firm’s currency derivative use on its exchange-rate exposure. However, a disadvantage
of this measure is that since firms were not required to disclose the direction
of the hedge during the period of our tests, we do not know whether the amounts
of foreign currency derivatives represent a short or a long position in the underlying
currency. This drawback in the data should not introduce any specific systematic bias though, as our hypothesis relates the absolute value of derivatives used with
the absolute value of exposure. Also, with the exception of a handful of firms, firms
do not break down derivatives amounts by individual currency. However, they seem
to first net positions in individual currencies before aggregating them. Despite the
possible measurement error introduced by such aggregation, our continuous variable
nevertheless provides valuable insights.