Risk Measurement and Hedging

45 Pages Posted: 11 May 1997

Date Written: April 1997

Abstract

It is difficult to judge the intentions and performance of corporate managers when it comes to their risk management programs. To evaluate the effectiveness of a risk management program or to test financial theories of risk management, a firms underlying risk exposure must be known. This paper examinesa setting where the firms derivative strategies are known and asks how well we can measure the effect of their hedging program on the firms fundamental accounting and market value measures. We study two gold mining firms which have diametrically opposed policies toward derivatives. American Barrick aggressively hedges its gold price risk using derivatives; Homestake Mining uses no derivatives. Instead Homestake Mining uses a combination of operating, financial, and accounting decisions to manage its risk. The result is that the exposure of the two firms equity to gold price risk is surprisingly similar. The multitude of risk management alternatives available to firms and thediversity of methods used by firms in the same industry means that tests of risk management theory must account for the different methods, not just the different objectives, which firms use in managing risk.

JEL Classification: G13

Suggested Citation

Petersen, Mitchell A. and Thiagarajan, S. Ramu, Risk Measurement and Hedging (April 1997). Available at SSRN: https://ssrn.com/abstract=39783 or http://dx.doi.org/10.2139/ssrn.39783

Mitchell A. Petersen (Contact Author)

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States
847-467-1281 (Phone)
847-491-5719 (Fax)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States
847-467-1281 (Phone)
847-491-5719 (Fax)

S. Ramu Thiagarajan

Mellon Capital Management Corporation ( email )

595 Market Street
Suite 3000
San Francisco, CA 94105
United States
415-975-3512 (Phone)

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