A Multirisk Approach to Measuring Corporate Hedging and its Determinants

Abstract

The willingness of a firm to hedge its activities is difficult to measure. A single indicator for the use of derivatives or even the notional or fair value of its hedging positions have been shown to entail limitations. In this paper, we introduce a new measure based on the number of risks hedged. From the US EDGAR database, we extract information on the hedging activity in four types of risks: interest rate, currency, commodity and equity. This allows us to better test the theoretical determinants of hedging. In a sample of firms from the S&P 500 over the period 2001 to 2005, we study the hedging behavior by industry and type of risk. While we confirm that leverage, foreign sales and size are the main empirical determinants for corporate hedging, we find significant variations across industries. We also provide empirical support for other determinants such as dividend policy, liquidity, tax credits, growth opportunities and managerial shareholdings. Confirming Adam, Dasgupta and Titman (2007) prediction, we observe that hedging policy heterogeneity is positively related to the competitive structure of the industry.

Keywords: Risk Management, Corporate Hedging, Derivatives, Foreign Currency Hedging, Interest Rate Hedging, Commodity Hedging, Equity Hedging, Financial Distress, Managerial Risk Aversion

JEL Classification: F3, G3, G30, G32