Corporate Hedging: The Relevance of Contract Specifications and Banking Relationships

30 Pages Posted: 28 May 1999

See all articles by Ian A. Cooper

Ian A. Cooper

London Business School

Antonio S. Mello

University of Wisconsin - Madison - Department of Finance, Investment and Banking

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Abstract

This article examines the contribution of hedging to firm value and the cost of hedging in a unified framework. Optimal hedging and firm value are explicitly linked to firm risk, the type of debt covenants and the relative priority of the hedging contract. It is shown that in some cases hedging is possible only if the counterparty to the forward contract also holds a significant portion of the debt. Also, the spread in the hedging contract reduces the optimal amount of hedging to less than the minimum-variance hedge ratio. Among other results this article elucidates why some firms hedge using forward contracts while other firms hedge in the futures markets, as well as why higher priority forward contracts are more efficient hedging vehicles.

JEL Classification: G13, G22, G33

Suggested Citation

Cooper, Ian Anthony and Mello, Antonio S., Corporate Hedging: The Relevance of Contract Specifications and Banking Relationships. Available at SSRN: https://ssrn.com/abstract=275832 or http://dx.doi.org/10.2139/ssrn.275832

Ian Anthony Cooper (Contact Author)

London Business School ( email )

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Antonio S. Mello

University of Wisconsin - Madison - Department of Finance, Investment and Banking ( email )

975 University Avenue
Madison, WI 53706
United States
608-263-3423 (Phone)
608-265-4195 (Fax)

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