The Decision to Hedge and the Extent to Hedge

Abstract:     
Using a broad sample of multiple commodity-inputs industries over the period of 1994-2008, the paper investigates the determinants for corporate decisions to commodity hedge and for the extent of hedging separately. Consistent with the literature, I find that firms are more likely to hedge when they are big, have risk management department set up and have more of their competitors hedge. I also find that firms change dynamically from non-hedgers to hedgers when their financial conditions improve. Furthermore, the paper investigates what determines the extent of hedging conditional on hedging and the cross-sectional and time series deviation of their hedge ratios. I find that firms with high-risk-preference CEOs tend to hedge less, are more likely to respond to past commodity price growth and to hedge differently from the industry average. Contrary to the general literature, the paper provides evidence that firms make decisions to hedge and to the extent of hedging based on distinct factors. The main determinants for the decisions to hedge are firms’ financial conditions, while the main determinants for the extent to hedge are CEO’s risk preferences.

Number of Pages in PDF File: 50

Keywords: corporate risk management, commodity hedging

JEL Classification: G32, L11

working papers series