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Capital expenditures, financial constraints, and the use of options

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  • Adam, Tim
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    Abstract

    This paper analyzes why gold mining firms use options instead of linear strategies to hedge their gold price risk. Consistent with financial constraints based theories, the largest and least financially constrained firms are the most likely to hedge with insurance strategies (put options), while more constrained firms finance the purchase of puts by selling calls (collars). The most financially constrained firms use strategies that involve selling calls. Firms with large investment programs are also more likely to use insurance rather than linear strategies. Firms' hedging instrument choices are also correlated with current market conditions, suggesting that managers' market views partially drive hedging instrument choices.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Financial Economics.

    Volume (Year): 92 (2009)
    Issue (Month): 2 (May)
    Pages: 238-251

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    Handle: RePEc:eee:jfinec:v:92:y:2009:i:2:p:238-251

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    Web page: http://www.elsevier.com/locate/inca/505576

    Related research

    Keywords: Risk management Hedging Insurance Instrument choice Speculation;

    References

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    1. Adam, Tim R. & Fernando, Chitru S., 2006. "Hedging, speculation, and shareholder value," Journal of Financial Economics, Elsevier, vol. 81(2), pages 283-309, August.
    2. Brown, Gregory W., 2001. "Managing foreign exchange risk with derivatives," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 401-448, May.
    3. René M. Stulz, 1996. "Rethinking Risk Management," Journal of Applied Corporate Finance, Morgan Stanley, vol. 9(3), pages 8-25.
    4. Gregory W. Brown & Klaus Bjerre Toft, 2002. "How Firms Should Hedge," Review of Financial Studies, Society for Financial Studies, vol. 15(4), pages 1283-1324.
    5. Peter Mackay & Sara B. Moeller, 2007. "The Value of Corporate Risk Management," Journal of Finance, American Finance Association, vol. 62(3), pages 1379-1419, 06.
    6. Geczy, Christopher & Minton, Bernadette A & Schrand, Catherine, 1997. " Why Firms Use Currency Derivatives," Journal of Finance, American Finance Association, vol. 52(4), pages 1323-54, September.
    7. Kenneth A. Froot & David S. Scharfstein & Jeremy C. Stein, 1992. "Risk Management: Coordinating Corporate Investment and Financing Policies," NBER Working Papers 4084, National Bureau of Economic Research, Inc.
    8. Peter Tufano, 1998. "The Determinants of Stock Price Exposure: Financial Engineering and the Gold Mining Industry," Journal of Finance, American Finance Association, vol. 53(3), pages 1015-1052, 06.
    9. Marti G. Subrahmanyam & Günter Franke & Richard C. Stapleton, 1998. "Who Buys and Who Sells Options: The Role and Pricing of Options in an Economy with Background Risk," New York University, Leonard N. Stern School Finance Department Working Paper Seires 98-063, New York University, Leonard N. Stern School of Business-.
    10. Moschini, Giancarlo & Lapan, Harvey E, 1992. "Hedging Price Risk with Options and Futures for the Competitive Firm with Production Flexibility," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 33(3), pages 607-18, August.
    11. Leland, Hayne E, 1980. " Who Should Buy Portfolio Insurance?," Journal of Finance, American Finance Association, vol. 35(2), pages 581-94, May.
    12. Moschini, GianCarlo & Lapan, Harvey E., 1995. "Hedging Role of Options and Futures Under Joint Price, Basis and Production Risk, The," Staff General Research Papers 5137, Iowa State University, Department of Economics.
    13. Gregory W. Brown & Peter R. Crabb & David Haushalter, 2006. "Are Firms Successful at Selective Hedging?," The Journal of Business, University of Chicago Press, vol. 79(6), pages 2925-2950, November.
    14. Tufano, Peter, 1996. " Who Manages Risk? An Empirical Examination of Risk Management Practices in the Gold Mining Industry," Journal of Finance, American Finance Association, vol. 51(4), pages 1097-1137, September.
    15. Alberto Moel, 2002. "When Are Real Options Exercised? An Empirical Study of Mine Closings," Review of Financial Studies, Society for Financial Studies, vol. 15(1), pages 35-64, March.
    16. Chidambaran, N. K. & Fernando, Chitru S. & Spindt, Paul A., 2001. "Credit enhancement through financial engineering: Freeport McMoRan's gold-denominated depositary shares," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 487-528, May.
    17. Moschini, Giancarlo & Lapan, Harvey, 1995. "The Hedging Role of Options and Futures under Joint Price, Basis, and Production Risk," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(4), pages 1025-49, November.
    18. Adam, Tim Rene, 2002. "Risk management and the credit risk premium," Journal of Banking & Finance, Elsevier, vol. 26(2-3), pages 243-269, March.
    19. Mitchell A. Petersen & S. Ramu Thiagarajan, 2000. "Risk Measurement and Hedging: With and Without Derivatives," Financial Management, Financial Management Association, vol. 29(4), Winter.
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    Citations

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    Cited by:
    1. Dirk G Baur, 2012. "An Empirical Analysis of Australian Gold Mining Firms," Working Paper Series 171, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
    2. Joan Farre-Mensa & Alexander Ljungqvist, 2013. "Do Measures of Financial Constraints Measure Financial Constraints?," NBER Working Papers 19551, National Bureau of Economic Research, Inc.
    3. Croci, Ettore & Jankensgård, Håkan, 2014. "CEO Age, Risk Incentives and Hedging Instrument Choice," Knut Wicksell Working Paper Series 2014/3, Knut Wicksell Centre for Financial Studies, Lund University.
    4. Mohamed Mnasri & Georges Dionne & Jean-Pierre Gueyie, 2013. "The Maturity Structure of Corporate Hedging: the Case of the U.S. Oil and Gas Industry," Cahiers de recherche 1337, CIRPEE.
    5. Al-Shboul, Mohammad & Anwar, Sajid, 2014. "Foreign exchange rate exposure: Evidence from Canada," Review of Financial Economics, Elsevier, vol. 23(1), pages 18-29.
    6. Lievenbrück, Martin & Schmid, Thomas, 2014. "Why do firms (not) hedge? — Novel evidence on cultural influence," Journal of Corporate Finance, Elsevier, vol. 25(C), pages 92-106.

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