Optimal Currency Hedging, Export, and Production in the Presence of Idiosyncratic Risk

This paper analyzes the behavior of a risk-averse exporting firm facing exchange rate uncertainty in the presence of forward markets. The existing literature on optimal hedging and production rules is extended by allowing for idiosyncratic risk. The paper provides an application of recent concepts in expected utility theory concerning optimal decisions in the presence of more than one risk (prudence, precautionary premium). Important results (separation theorem, full hedging theorem) still hold, but optimal speculative positions are smaller due to the existence of idiosyncratic risk.