Pass-through, Exposure, and the Currency Composition of Debt

I propose a model of production and financing for firms in an open economy, which features financial frictions and imperfect competition in the domestic goods market. The optimal currency composition of debt comes from the motive to hedge currency exposure, which arises from the industry equilibrium in the domestic goods market. Using a panel dataset of traded Mexican firms, I find evidence that firms hedge their foreign exchange rate exposure using foreign denominated debt. A calibrated version of the model is used to show that the hedging motive alone can rationalize the amount of foreign debt observed in the data, even the seemingly large amounts issued by firms with no exports. JEL Codes: G30, G32.