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The Use of Options in Corporate Risk Management

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  • Bartram, Söhnke M.

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.

Suggested Citation

  • Bartram, Söhnke M., 2004. "The Use of Options in Corporate Risk Management," MPRA Paper 6663, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:6663
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    File URL: https://mpra.ub.uni-muenchen.de/6663/1/MPRA_paper_6663.pdf
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    References listed on IDEAS

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    Cited by:

    1. Kevin Aretz & Söhnke M. Bartram, 2010. "Corporate Hedging And Shareholder Value," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 33(4), pages 317-371, December.

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    More about this item

    Keywords

    Options; derivatives; risk management; exposure; corporate finance;
    All these keywords.

    JEL classification:

    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
    • F3 - International Economics - - International Finance
    • G3 - Financial Economics - - Corporate Finance and Governance

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