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The Use of Options in Corporate Risk Management

Managerial Finance, Vol. 32, No. 2, pp. 160-181, 2006

30 Pages Posted: 5 Jun 2007 Last revised: 10 Mar 2014

Söhnke M. Bartram

Warwick Business School - Department of Finance

Date Written: January 7, 2004

Abstract

This paper investigates the motivations and practice of nonfinancial firms with regard to using financial options in their risk management activities. To this end, it provides a comprehensive account of the existing empirical evidence on the use of derivatives in general and options in particular by nonfinancial corporations across different underlyings and countries. Overall, a significant number of 15%-25% of the firms outside the financial sector use financial options. This reflects the fact that options are very versatile risk management instruments that can be used to hedge various types of exposures, linear as well as nonlinear. In particular, options are a useful component of corporate risk management if exposures are uncertain, e.g. due to price and quantity risk. Depending on the correlation between price and quantity risk, the optimal hedge portfolio consists of a varying combination of linear and nonlinear risk management instruments. Moreover, the accounting treatment as well as liquidity effects can impact the choice of derivative instrument. At the same time, there may be agency-related incentives to use options because of their role to present dual bets on both direction as well as future volatility of the underlying.

Keywords: Options, derivatives, risk management, exposure, corporate finance

JEL Classification: G3, F4, F3

Suggested Citation

Bartram, Söhnke M., The Use of Options in Corporate Risk Management (January 7, 2004). Managerial Finance, Vol. 32, No. 2, pp. 160-181, 2006. Available at SSRN: https://ssrn.com/abstract=991261

Söhnke M. Bartram (Contact Author)

Warwick Business School - Department of Finance ( email )

Coventry, CV4 7AL
United Kingdom
+44 (24) 7657 4168 (Phone)
+1 425 952 1070 (Fax)

HOME PAGE: http://go.warwick.ac.uk/sbartram/

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