Exchange rate risk management for contractors within a hybrid payment scheme: a case study in Punta del Este, Uruguay

Martín Egozcue

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We develop a model to analyse and offer solutions for contractors to efficiently manage exchange rate risk within a hybrid payment scheme in Punta del Este’s real estate market.
The study employs three distinct theoretical models to determine optimal profit hedging strategies for contractors: variance minimization, mean-variance criterion, and expected utility theory.
The study goes beyond theoretical development and validates the effectiveness of these models by using data from a hypothetical real estate development project in Punta del Este, Uruguay, conducting both ex-ante and ex-post analyses.
We show that the proposed hedging strategies effectively mitigate exchange rate risk, even in the presence of property price risk, while surpassing the profit of an unhedged strategy.

Abstract

This paper investigates the strategies contractors can employ to mitigate the exchange rate risks in hybrid payment systems. In our analysis, contractors face exchange rate risk, due to mismatches between their revenue and cost currencies, as well as property price risk, since they receive a portion of their revenue in the form of dwelling units. We rigorously compare the performance of three distinct risk models within the context of real estate development in Punta del Este, Uruguay. By evaluating these models against empirical data from a hypothetical project, our research provides valuable insights into their effectiveness in managing exchange rate risk. This addresses the critical need to validate risk models in the emerging real estate market of Punta del Este. Our analysis demonstrates a significant reduction in risk and higher expected profits compared with strategies that do not involve hedging.

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