To Hedge or Not to Hedge? A quantitative analysis of Natural vs. Active FX-Hedging Strategies in the Automotive Industry

Sammanfattning

This research evaluates the impact of active foreign-exchange hedging compared to an unhedged benchmark portfolio on the cash-flow risk of Volvo AB. EBITDA is used as a measure of operating cash flow, while a Cash-Flow-at-Risk approach based on exposure analysis is used to quantify the sensitivity of Volvo AB to changes in the USD/SEK, EUR/SEK, and GBP/SEK currency pairs. The exposures are measured with a rolling window of 40 quarters and include macro-financial control variables such as interest rate changes, inflation, market conditions, and global supply chain pressures. The exposure analysis results are used in a Monte Carlo simulation to compare the performance of three FX hedge methods, namely, a simple forward hedge and two FX options hedges. As expected, Volvo’s FX exposures appear unstable and vary significantly over time after 2020. The forward hedge achieves the highest reductions of 95% CFaR and simulated EBITDA volatility. However, such a hedge strategy sacrifices the company’s upside potential, since the simulated returns exhibit significant skewness to the right. The option hedges maintain the upside, yet do not perform well in protecting against the downside, especially accounting for option premiums paid. Overall, this research finds that FX hedging can lower Volvo’s downside cash-flow risk; however, the effectiveness of hedging measures remains limited, since there is a substantial non-FX component in EBITDA volatility. This result illustrates that exposure-based CFaR can not only be used to compare hedging strategies but also identify hedgeable risks.