Does Hedging with Derivatives Reduce the Market's Perception of Credit Risk?
53 Pages Posted: 19 Aug 2015 Last revised: 25 Jul 2016
Date Written: July 24, 2016
Risk management is the most widely-cited reason that non-ﬁnancial corporations use derivatives. If hedging programs are eﬀective, then ﬁrms using derivatives should have lower credit risk than those that do not. Surprisingly, we ﬁnd that ﬁrms with derivatives positions without a hedge accounting designation (typically higher basis risk) have higher CDS spreads than ﬁrms that do not hedge at all. We do not ﬁnd evidence that these non-designated positions are associated with future credit realizations. 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: Suggested Citation