Inflation Risk, Hedging, and Exports

This paper analyzes optimal production and hedging decisions of a risk-averse exporting firm in a developing country. The firm cares about real profits, since the spot exchange rate and the domestic price level are uncertain. It is demonstrated that a separation property holds although there are two sources of risk and only one hedging instrument exists. The authors examine the optimal risk management of the firm. In contrast to most hedging models, the real risk premium is important for the optimal hedging strategy.