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Liquidity management and corporate demand for hedging and insurance

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Author Info

  • Rochet, Jean-Charles
  • Villeneuve, Stéphane

Abstract

We analyze the demand for hedging and insurance by a firm facing cash-flow risks. We study how the firm's liquidity management policy interacts with two types of risk: a Brownian risk that can be hedged through a financial derivative, and a Poisson risk that can be insured by an insurance contract. We find that the patterns of insurance and hedging decisions are pole apart: cash-poor firms should hedge but not insure, whereas the opposite is true for cash-rich firms. We also find non-monotonic effects of profitability. This may explain the mixed findings of empirical studies on corporate demand for hedging and insurance.

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Bibliographic Info

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

Volume (Year): 20 (2011)
Issue (Month): 3 (July)
Pages: 303-323

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Handle: RePEc:eee:jfinin:v:20:y:2011:i:3:p:303-323

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Web page: http://www.elsevier.com/locate/inca/622875

Related research

Keywords: Liquidity management Risk management Corporate hedging;

References

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  1. Merton, Robert C, 1978. "On the Cost of Deposit Insurance When There Are Surveillance Costs," The Journal of Business, University of Chicago Press, vol. 51(3), pages 439-52, July.
  2. 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.
  3. 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.
  4. Mayers, David & Smith, Clifford W, Jr, 1990. "On the Corporate Demand for Insurance: Evidence from the Reinsurance Market," The Journal of Business, University of Chicago Press, vol. 63(1), pages 19-40, January.
  5. Stulz, René M., 1984. "Optimal Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 19(02), pages 127-140, June.
  6. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-29, May.
  7. Dumas, Bernard, 1991. "Super contact and related optimality conditions," Journal of Economic Dynamics and Control, Elsevier, vol. 15(4), pages 675-685, October.
  8. Bhattacharya, Sudipto & Plank, Manfred & Strobl, Gunter & Zechner, Josef, 2002. "Bank capital regulation with random audits," Journal of Economic Dynamics and Control, Elsevier, vol. 26(7-8), pages 1301-1321, July.
  9. Hayne E. Leland, 1998. "Agency Costs, Risk Management, and Capital Structure," Journal of Finance, American Finance Association, vol. 53(4), pages 1213-1243, 08.
  10. Mayers, David & Smith, Clifford W, Jr, 1982. "On the Corporate Demand for Insurance," The Journal of Business, University of Chicago Press, vol. 55(2), pages 281-96, April.
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Citations

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Cited by:
  1. Nataliya Klimenko, 2013. "Tailoring Bank Capital Regulation for Tail Risk," AMSE Working Papers 1310, Aix-Marseille School of Economics, Marseille, France, revised Feb 2013.
  2. Nataliya Klimenko, 2013. "Tailoring Bank Capital Regulation for Tail Risk," Working Papers halshs-00796490, HAL.
  3. Gatopoulos, Georgios & Loubergé, Henri, 2013. "Combined use of foreign debt and currency derivatives under the threat of currency crises: The case of Latin American firms," Journal of International Money and Finance, Elsevier, vol. 35(C), pages 54-75.

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