Derivative Instruments and Their Use for Hedging by U.S. Non-Financial Firms: A Review of Theories and Empirical Evidence
Journal of Applied Business and Economics, Vol. 7, No. 2, pp. 35-57, 2007
26 Pages Posted: 17 Jan 2008 Last revised: 14 May 2008
The purpose of this paper is to review the literature on the use of financial instruments known as derivatives. Derivatives use is a relatively recent phenomenon, dating back to around the 1970s. In the past 15 years a significant theoretical and empirical literature has emerged that examines why non-financial firms use derivatives. This review weaves a common thread through the literature on the use of derivatives that covers economics, accounting, and finance. We present empirical evidence from extant research that shows the use of derivatives by U.S. non-financial firms has increased over time. We review the basic theory of hedging based on costly external finance that provides a basis for organizing and detailing the empirical evidence on derivatives use. The econometric evidence indicates the importance of costly external finance in determining derivatives use and provides support for the view that non-financial firms use derivatives for hedging. Our review also touches on some macroeconomic implications of derivatives use, suggesting that the use of derivative instruments may moderate the impact of monetary policy shocks.
Keywords: Derivatives, Hedging, External Finance
JEL Classification: G31, G32, E60
Suggested Citation: Suggested Citation