Risk Measurement and Hedging

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.

Number of Pages in PDF File: 45

JEL Classification: G13

working papers series