Liquidity Risk and Corporate Hedging with Futures

7 Pages Posted: 4 May 2011

See all articles by K. S. Maurice Tse

K. S. Maurice Tse

The University of Hong Kong - School of Economics and Finance

Kit Pong Wong

affiliation not provided to SSRN

Date Written: May 2011

Abstract

This paper examines the hedging behaviour of a value‐maximizing firm that exists for two periods. The firm faces uncertain income and is subject to tax asymmetries with no loss‐offset provisions. The firm has access to unbiased futures contracts in each period for hedging purposes. We impose a liquidity constraint on the firm. Specifically, whenever the net interim loss due to its first‐period futures position exceeds a predetermined threshold level, the firm is forced to terminate its risk management program and, therefore, is prohibited from trading the futures contracts in the second period. We show that the liquidity‐constrained firm optimally adopts a full‐hedge via its second‐period futures position to minimize the extent of the income risk and an under‐hedge via its first‐period futures position to limit the degree of the liquidity risk.

Suggested Citation

Tse, Maurice K. S. and Wong, Kit Pong, Liquidity Risk and Corporate Hedging with Futures (May 2011). Pacific Economic Review, Vol. 16, Issue 2, pp. 229-235, 2011, Available at SSRN: https://ssrn.com/abstract=1830944 or http://dx.doi.org/10.1111/j.1468-0106.2011.00544.x

Maurice K. S. Tse (Contact Author)

The University of Hong Kong - School of Economics and Finance ( email )

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Kit Pong Wong

affiliation not provided to SSRN

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