How Does Hedge Designation Impact the Market's Perception of Credit Risk?

61 Pages Posted: 19 Aug 2015 Last revised: 2 Apr 2018

Sriya Anbil

Board of Governors of the Federal Reserve System

Alessio Saretto

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics

Heather Tookes

Yale University - Yale School of Management; Yale University - International Center for Finance

Multiple version iconThere are 2 versions of this paper

Date Written: March 24, 2018

Abstract

Non-financial corporations typically cite risk management as the primary reason for their derivatives use. If hedging programs are effective, then firms using derivatives should have lower credit risk than those that do not. Consistent with this idea, we find that CDS spreads are lower for firms with derivatives positions that are designated as accounting hedges (typically low basis risk) compared to firms without the accounting hedge designation as well as firms that do not use derivatives. Surprisingly, we find that firms with derivatives positions without a hedge accounting designation have higher CDS spreads than firms that do not hedge with derivatives at all. We do not find evidence that these non-designated positions are associated with future credit realizations, as captured by changes in either credit ratings or CDS spreads. We examine alternative explanations and find evidence that is consistent with a market penalty for high basis risk positions when overall market conditions are poor.

Keywords: risk management, derivatives, SFAS 133, SFAS 161, basis risk

JEL Classification: G32

Suggested Citation

Anbil, Sriya and Saretto, Alessio and Tookes, Heather, How Does Hedge Designation Impact the Market's Perception of Credit Risk? (March 24, 2018). Available at SSRN: https://ssrn.com/abstract=2643920 or http://dx.doi.org/10.2139/ssrn.2643920

Sriya Anbil

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Alessio Saretto

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics ( email )

800 Campbell Road
SM 31
Richardson, TX 75080
United States
972-883-5907 (Phone)

HOME PAGE: http://www.utdallas.edu/~axs125732

Heather Tookes (Contact Author)

Yale University - Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

Yale University - International Center for Finance ( email )

Box 208200
New Haven, CT 06520
United States

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