Embracing Risk: Hedging Policy for Firms with Real Options

59 Pages Posted: 16 Mar 2011 Last revised: 11 Aug 2019

See all articles by Ilona Babenko

Ilona Babenko

Arizona State University

Yuri Tserlukevich

Arizona State University (ASU)

Date Written: August 9, 2019

Abstract

We build a dynamic cash and risk management model of a 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, manage safer assets, and have easier access to external financing. In contrast, financially constrained firms will hedge less aggressively. Using hand-collected data for U.S. oil and gas producers covering the period of unprecedented industry growth during 2001-2018, we find support for model predictions.

Keywords: hedging, risk management, investment options, financing constraints, investment

Suggested Citation

Babenko, Ilona and Tserlukevich, Yuri, Embracing Risk: Hedging Policy for Firms with Real Options (August 9, 2019). Available at SSRN: https://ssrn.com/abstract=1785334 or http://dx.doi.org/10.2139/ssrn.1785334

Ilona Babenko

Arizona State University ( email )

Department of Finance
W.P. Carey School of Business
Tempe, AZ 85287
United States

Yuri Tserlukevich (Contact Author)

Arizona State University (ASU) ( email )

Farmer Building 440G PO Box 872011
Tempe, AZ 85287
United States

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