Corporate Risk Management: Integrating Liquidity, Hedging, and Operating Policies

Abstract:     
We analyze the value created by a dynamic integrated risk management strategy involving liquidity management, derivatives hedging and operating flexibility, in the presence of several frictions. We show that liquidity serves a critical and distinct role in risk management, justifying high levels of cash. We find that the marginal value associated with derivatives hedging is likely to be low, though we explain why some empirical studies find a higher value. We explore the complex interactions between operating flexibility and financial risk management, finding that substitution effects are non-monotonic, and are affected by operating leverage, the nature of operating flexibility, and the effectiveness of the hedging instrument.

Number of Pages in PDF File: 35

Keywords: Risk Management, Hedging, Liquidity, Flexibility

JEL Classification: G32

Accepted Paper Series