Abstract

http://ssrn.com/abstract=2103562
 
 

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Dynamic Risk Management: Investment, Capital Structure, and Hedging in the Presence of Financial Frictions


Diego Amaya


University of Quebec at Montreal (UQAM) - Finance Department

Genevieve Gauthier


HEC Montreal

Thomas-Olivier Léautier


University of Toulouse 1 - Toulouse School of Economics (TSE)

February 10, 2013


Abstract:     
This paper develops a dynamic risk management model to determine a firm's optimal risk management strategy. This strategy has two elements: First, for low leverage values, the firm fully hedges its operating cash flow exposure, due to the convexity of its cost of capital. When leverage exceeds a very high threshold, the firm gambles for resurrection and stops hedging Second, the firm manages its capital structure through dividend distributions and investment. When leverage is low, the firm replaces depreciated assets, fully invests in opportunities if they arise, and distribute dividends; all of these together to achieve its optimal capital structure. As leverage increases, the firm stops paying dividends, while fully investing. After a certain leverage, the firm also reduces investment, until it stops investing completely. The model predictions are consistent with empirical observations.

Number of Pages in PDF File: 44

Keywords: Dynamic programming, risk management, capital structure, hedging

JEL Classification: G32, C61

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Date posted: July 11, 2012 ; Last revised: February 13, 2013

Suggested Citation

Amaya, Diego and Gauthier, Genevieve and Léautier, Thomas-Olivier, Dynamic Risk Management: Investment, Capital Structure, and Hedging in the Presence of Financial Frictions (February 10, 2013). Available at SSRN: http://ssrn.com/abstract=2103562 or http://dx.doi.org/10.2139/ssrn.2103562

Contact Information

Diego Amaya
University of Quebec at Montreal (UQAM) - Finance Department ( email )
Canada
Genevieve Gauthier (Contact Author)
HEC Montreal ( email )
3000, Chemin de la Côte-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada
Thomas-Olivier Léautier
University of Toulouse 1 - Toulouse School of Economics (TSE) ( email )
Place Anatole-France
Toulouse Cedex, F-31042
France
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