A Signaling Theory of Derivatives-Based Hedging

49 Pages Posted: 1 Feb 2016 Last revised: 20 Nov 2017

See all articles by Fernando Anjos

Fernando Anjos

NOVA School of Business and Economics

Adam Winegar

BI Norwegian Business School

Date Written: November 17, 2017


We model a commodity producing firm that has private information about future volume and requires outside financing to fund a growth opportunity. Due to costly financial distress, a firm’s first-best strategy is to sell forward its future production, avoiding any price risk. Low-volume firms, however, have an incentive to mimic, which in equilibrium distorts the hedging strategy of high-volume firms. Under certain conditions, high-volume firms signal their type by hedging more than they would under their first-best strategy. In general, high-volume firms signal by taking on excess risk through derivative positions. When allowing firms to use multiple types of derivatives, we show that high-volume firms use both options and forwards, while low-volume firms only use forwards. The model suggests that heterogeneous and prima facie non-optimal hedging policies may be due to signaling and not speculation or risk shifting.

Keywords: hedging, risk management, derivatives, signaling

JEL Classification: G32, D82

Suggested Citation

Anjos, Fernando and Winegar, Adam, A Signaling Theory of Derivatives-Based Hedging (November 17, 2017). Paris December 2017 Finance Meeting EUROFIDAI - AFFI, Available at SSRN: https://ssrn.com/abstract=2725270 or http://dx.doi.org/10.2139/ssrn.2725270

Fernando Anjos

NOVA School of Business and Economics ( email )

Campus de Carcavelos
Rua da Holanda, 1
Carcavelos, 2775-405

HOME PAGE: http://sites.google.com/site/fernandoanjossite/

Adam Winegar (Contact Author)

BI Norwegian Business School ( email )

Nydalsveien 37
Oslo, 0442

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