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The Use of Options in Corporate Risk Management

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Author Info
Bartram, Söhnke M.

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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.

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File URL: http://mpra.ub.uni-muenchen.de/6663/
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 6663.

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Date of creation: 07 Jan 2004
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Handle: RePEc:pra:mprapa:6663

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Related research
Keywords: Options derivatives risk management exposure corporate finance

Find related papers by 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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  1. 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. [Downloadable!] (restricted)
  2. Gregory W. Brown & Klaus Bjerre Toft, 2002. "How Firms Should Hedge," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 15(4), pages 1283-1324.
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  6. Shawn D. Howton & Steven B. Perfect, 1998. "Currency and Interest-Rate Derivatives Use in US Firms," Financial Management, Financial Management Association, vol. 27(4), Winter.
  7. John R. Graham & Daniel A. Rogers, 2002. "Do Firms Hedge in Response to Tax Incentives?," Journal of Finance, American Finance Association, vol. 57(2), pages 815-839, 04. [Downloadable!] (restricted)
  8. Ware, Roger & Winter, Ralph, 1988. "Forward markets, currency options and the hedging of foreign exchange risk," Journal of International Economics, Elsevier, vol. 25(3-4), pages 291-302, November. [Downloadable!] (restricted)
  9. Henk Berkman & Michael E. Bradbury, 1996. "Empirical Evidence on the Corporate Use of Derivatives," Financial Management, Financial Management Association, vol. 25(2), Summer.
  10. Bartram, Sohnke M., 2004. "Linear and nonlinear foreign exchange rate exposures of German nonfinancial corporations," Journal of International Money and Finance, Elsevier, vol. 23(4), pages 673-699, June. [Downloadable!] (restricted)
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  11. Stulz, ReneM., 1990. "Managerial discretion and optimal financing policies," Journal of Financial Economics, Elsevier, vol. 26(1), pages 3-27, July. [Downloadable!] (restricted)
  12. Sohnke M. Bartram & Gregory W. Brown & Frank R. Fehle, 2003. "International Evidence on Financial Derivatives Usage," Finance 0307003, EconWPA, revised 24 Jul 2003. [Downloadable!]
  13. Henk Berkman & Michael E. Bradbury & Phil Hancock & Clare Innes, 2002. "Derivative financial instrument use in Australia," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 42(2), pages 97-109. [Downloadable!] (restricted)
  14. G. David Haushalter, 2000. "Financing Policy, Basis Risk, and Corporate Hedging: Evidence from Oil and Gas Producers," Journal of Finance, American Finance Association, vol. 55(1), pages 107-152, 02. [Downloadable!] (restricted)
  15. Gerald D. Gay & Jouahn Nam, 1998. "The Underinvestment Problem and Corporate Derivatives Use," Financial Management, Financial Management Association, vol. 27(4), Winter.
  16. 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. [Downloadable!] (restricted)
  17. Bartram, S.M., 2000. "Corporate Risk Management as a Lever for Shareholder Value Creation," Papers 00-58, Southern California - School of Business Administration.
    Other versions:
  18. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November. [Downloadable!] (restricted)
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