Empirical evidence concerning incentives to hedge transaction and translation exposures

We investigate Swedish firms’ use of financial hedges against foreign exchange exposure. Our survey data lets us distinguish between translation exposure and transaction exposure hedging. Survey responses indicate that over 50% of the sampled firms employ financial hedges, and that transaction exposure is more frequently hedged than is translation exposure. The likelihood of using financial hedges increases with firm size and exposure, and liquidity constraints are important in explaining transaction exposure hedging. Importantly, the existence of loan covenants accounts for translation exposure hedging, suggesting that firms hedge translation exposure to avoid violating loan covenants.