Risk Management and Firm Value: Evidence from Weather Derivatives

49 Pages Posted: 11 Mar 2009 Last revised: 20 Mar 2015

Francisco Perez-Gonzalez

National Bureau of Economic Research (NBER); Instituto Tecnológico Autónomo de México (ITAM)

Hayong Yun

Michigan State University - Department of Finance

Date Written: September 2010

Abstract

This paper examines the impact of financial innovation on firm value, investment, and financing decisions. More specifically, we examine the effect of the introduction of weather derivatives on electric and gas utilities, arguably some of the most weather-exposed businesses in the economy. Weather derivatives were introduced in 1997 to help firms manage their weather-related risk exposure. We derive instruments for weather derivative use based on historical (pre-1997) weather exposure. Intuitively, firms whose cash flows have historically fluctuated with changing weather conditions are, relative to other firms, more likely to use weather derivatives once they become available, irrespective of their investment opportunities. Using data from U.S. energy firms, we find that weather derivatives lead to higher market valuations, investments, and leverage. Overall, our results demonstrate that financial innovation can significantly affect firm outcomes and that risk management meaningfully affects valuation, investments, and financing decisions.

Keywords: risk management, hedging, derivatives, firm value, capital structure, debt policy, weather risk

JEL Classification: G30, G32

Suggested Citation

Perez-Gonzalez, Francisco and Yun, Hayong, Risk Management and Firm Value: Evidence from Weather Derivatives (September 2010). AFA 2010 Atlanta Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1357385 or http://dx.doi.org/10.2139/ssrn.1357385

Francisco Perez-Gonzalez

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Instituto Tecnológico Autónomo de México (ITAM) ( email )

Av. Camino a Sta. Teresa 930
Col. Héroes de Padierna
Mexico City, D.F. 01000, Federal District 01080
Mexico

Hayong Yun (Contact Author)

Michigan State University - Department of Finance ( email )

645 N Shaw Lane, Room 339
East Lansing, MI 48824-1122
United States
517-884-0549 (Phone)

HOME PAGE: http://https://sites.google.com/site/hayongy/

Paper statistics

Downloads
657
Rank
30,893
Abstract Views
3,022