Embracing Risk: Hedging Policy for Firms with Real Options
59 Pages Posted: 16 Mar 2011 Last revised: 11 Aug 2019
Date Written: August 9, 2019
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: Suggested Citation