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The Use of Foreign Currency Derivatives and Firm Market Value

Darden School Working Paper No. 97-23

48 Pages Posted: 2 Nov 1998  

George Allayannis

University of Virginia - Darden School of Business

James Weston

Rice University - Jesse H. Jones Graduate School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: October 1998

Abstract

This paper examines the use of foreign currency derivatives (FCDs) by a sample of 720 large U.S. nonfinancial firms between 1990 and 1995 and its potential impact on firm value. Using Tobin's Q as an approximation of a firm's market valuation, we find a positive relationship between firm value and the use of FCDs. The hedging premium is statistically and economically significant mostly after 1993 and is on average 5.7\% of firm value. This result is robust to a) controls for size, profitability, leverage, growth opportunities, ability to access financial markets, industrial and geographical diversification, credit quality, industry classification (4-digit SIC), year-dummies and firm fixed-effects; b) the use of a weight-adjusted industry Tobin's Q and other measures of value, such as the market to book and the market to sales ratios; and, c) alternative estimation techniques that handle the potential impact of outliers. Using the ratio of foreign currency derivatives to foreign sales as a proxy for the percentage of exposure that a firm hedges, we observe a significant dispersion in our measure of the hedge ratio. In univariate tests we find a nonlinear relationship between Q and our proxy. However, firm-specific factors explain this relationship in multivariate tests and it appears that firms are hedging optimally.

JEL Classification: G15, G30

Suggested Citation

Allayannis, George and Weston, James, The Use of Foreign Currency Derivatives and Firm Market Value (October 1998). Darden School Working Paper No. 97-23. Available at SSRN: https://ssrn.com/abstract=138498 or http://dx.doi.org/10.2139/ssrn.138498

George Allayannis (Contact Author)

University of Virginia - Darden School of Business ( email )

Box 6550
Charlottesville, VA 22906-6550
United States
434-924-3434 (Phone)

HOME PAGE: http://faculty.darden.edu/allayannisy

James Peter Weston

Rice University - Jesse H. Jones Graduate School of Business ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005
United States
713-348-4480 (Phone)
713-348-6331 (Fax)

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