Corporate Hedging and Speculation with Derivatives

Abstract

Against the backdrop of the role of derivatives in the recent financial crisis, this paper investigates the effect of derivatives usage on the risk and exposure of nonfinancial firms around the world, and presents evidence that they use derivatives for hedging purposes. There is no evidence of corporate speculation with derivatives for firms in individual countries or for different types of derivatives, except for marginally higher net commodity price exposure of firms using commodity price derivatives. Firms use derivatives for hedging purposes independent of access to derivatives or country-level corporate governance. While there are no differences in risk between firms in countries with strong and weak shareholder rights, the reduction in risk is larger for firms in countries where creditor rights are weak or where derivatives are readily available. Consequently, policy makers could facilitate corporate hedging activities by pursuing strategies that encourage the development of local-currency derivatives markets. Given the similarity in the use and effect of derivatives across countries, internationally harmonized regulation of derivatives markets may be adequate.

Keywords: Derivatives, risk management, hedging, speculation, corporate finance, international finance, corporate governance

JEL Classification: G3, F4, F3