Embracing Risk: Hedging Policy for Firms with Real Options
63 Pages Posted: 16 Mar 2011 Last revised: 18 Aug 2021
Date Written: August 17, 2019
Abstract
We build a dynamic risk management model of a financially constrained firm maximizing financing for its investment projects. Because of the option to abandon investment at low profitability and to expand investment at high profitability, hedging can be suboptimal. The model
predicts that firms will engage in more risk management when they have a
higher net worth and have easier access to external
financing. In contrast, financially constrained firms will hedge less
aggressively. Using detailed data for U.S. oil and gas producers
covering the period of unprecedented industry growth during 1999-2019, we
find support for model predictions.
Keywords: hedging, risk management, investment options, financing constraints, investment
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