Hedging the Value of Waiting

21 Pages Posted: 11 Sep 2003

See all articles by Glenn Boyle

Glenn Boyle

University of Canterbury - Economics and Finance; Sapere Research Group

Graeme Guthrie

Victoria University of Wellington - School of Economics & Finance

Date Written: February 12, 2004

Abstract

We analyze the optimal hedging policy of a firm that has flexibility in the timing of investment. Conventional wisdom suggests that hedging adds value by alleviating the under-investment problem associated with capital market frictions. However, our model shows that hedging also adds value by allowing investment to be delayed in circumstances where the same frictions would cause it to commence prematurely. Thus, hedging can have the perverse effect of reducing investment. We also show that greater timing flexibility increases the optimal quantity of hedging, but has a non-monotonic effect on the additional value created by hedging. These results may help explain the empirical findings that investment rates do not differ between hedgers and non-hedgers, and that hedging propensities do not depend on standard measures of growth opportunities.

Keywords: hedging, investment timing flexibility

JEL Classification: G31, G32

Suggested Citation

Boyle, Glenn and Guthrie, Graeme, Hedging the Value of Waiting (February 12, 2004). Available at SSRN: https://ssrn.com/abstract=427900 or http://dx.doi.org/10.2139/ssrn.427900

Glenn Boyle (Contact Author)

University of Canterbury - Economics and Finance ( email )

Private Bag 4800
Christchurch
New Zealand

Sapere Research Group ( email )

Level 9, Pencarrow House
1 Willeston St
Wellington, 6140
New Zealand

Graeme Guthrie

Victoria University of Wellington - School of Economics & Finance ( email )

P.O. Box 600
Wellington 6140
New Zealand
64 4 463 5763 (Phone)

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