Who Hedges More When Leverage is Endogenous? A Testable Theory of Corporate Risk Management Under General Distributional Conditions

Posted: 5 Oct 2006 Last revised: 19 Jul 2011

Lutz Hahnenstein

Talanx Asset Management GmbH

Klaus Röder

University of Regensburg - Faculty of Business, Economics & Information Systems

Date Written: September 11, 2006

Abstract

This paper develops a theory of a firm's hedging decision with endogenous leverage. In contrast to previous models in the literature, our framework is based on less restrictive distributional assumptions and allows a closed-form analytical solution to the joint optimization problem. Using anecdotal evidence of greater benefits of risk management for firms selling "credence goods" or products that involve long-term relationships, we prove that those optimally leveraged firms, which face more convex indirect bankruptcy cost functions, will choose higher hedge ratios. Moreover, we suggest a new approach to test this relationship empirically.

Keywords: corporate hedging, risk management, leverage, capital structure, bankruptcy, financial distress

JEL Classification: G32, G39

Suggested Citation

Hahnenstein, Lutz and Röder, Klaus, Who Hedges More When Leverage is Endogenous? A Testable Theory of Corporate Risk Management Under General Distributional Conditions (September 11, 2006). Review of Quantitative Finance and Accounting, Vol. 28, pp. 353-392, 2007. Available at SSRN: https://ssrn.com/abstract=934589

Lutz Hahnenstein (Contact Author)

Talanx Asset Management GmbH ( email )

Charles-de-Gaulle-Platz 1
Cologne, 50679
Germany

Klaus Röder

University of Regensburg - Faculty of Business, Economics & Information Systems ( email )

Universitstrasse 31
Regensberg D-93053
Germany

Paper statistics

Abstract Views
764