Is the FX derivatives market effective and efficient in reducing currency risk?

2005. External Vulnerability and Preventive Policies.

Esteban Jadresic, Jorge Selaive C

Abstract:

We explore whether the foreign exchange (FX) derivatives market effectively and efficiently reduces the vulnerability to foreign exchange rate fluctuations. Cross-country evidence suggests that development of the FX derivatives market does not boost up spot exchange rate volatility and reduces aggregate exposure to currency risk. Interday and intraday evidence for Chile shows that activity in the forward market has not been associated with higher volatility in the exchange rate following the adoption of a floating exchange rate regime. It also cast doubts about the belief that large participants in the FX market trade based on asymmetric information that may be price relevant. These findings support the view that development of the FX derivatives market is valuable to reduce aggregate currency risk.

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