Risk Management with Default-Risky Forwards
AbstractTo study the impact of counter-party default risk of forward contracts on a firm’s production and hedging decisions, I use a model of a risk-averse competitive firm under price uncertainty. I find that if expected profits from forward contracts are zero, the hedge ratio is not affected by default risk under general preferences and general price distributions. My analysis shows that if the size of a firm’s forward position does not affect the counter-party’s default probability, default risk is no reason to reduce hedge ratios. However, a firm’s optimal output is negatively affected by default risk, and it is generally advisable to hedge default risk with credit derivatives.
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Bibliographic InfoArticle provided by LMU Munich School of Management in its journal Schmalenbach Business Review.
Volume (Year): 62 (2010)
Issue (Month): 2 (April)
Default Risk; Forwards; Hedging; Production; Risk Management.;
Find related papers by JEL classification:
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- G30 - Financial Economics - - Corporate Finance and Governance - - - General
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- Adam-Müller, Axel F.A. & Nolte, Ingmar, 2011. "Cross hedging under multiplicative basis risk," Journal of Banking & Finance, Elsevier, vol. 35(11), pages 2956-2964, November.
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