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Why Most Firms Choose Linear Hedging Strategies

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  • Dennis Frestad

Abstract

Abstract I investigate the efficiency of alternative hedging strategies of nonfinancial firms facing hedgeable price risk, unhedgeable quantity risk, and financial contracting costs in low-profit events. The analysis suggests that variance-minimizing hedging strategies are very close in economic terms to optimal, value-maximizing hedging strategies for most firms. Furthermore, the marginal gains from shifting to nonlinear hedging strategies are often small enough to be neglected. These results illuminate some puzzling findings in survey studies of firms' hedging practices and suggest an alternative view on firms' selective hedging practices termed "cautious selective hedging." Copyright (c) 2009 The Southern Finance Association and the Southwestern Finance Association.

Suggested Citation

  • Dennis Frestad, 2009. "Why Most Firms Choose Linear Hedging Strategies," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 32(2), pages 157-167.
  • Handle: RePEc:bla:jfnres:v:32:y:2009:i:2:p:157-167
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    References listed on IDEAS

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    1. 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.
    2. Gerald D. Gay & Jouahn Nam & Marian Turac, 2002. "How Firms Manage Risk: The Optimal Mix Of Linear And Non-Linear Derivatives," Journal of Applied Corporate Finance, Morgan Stanley, vol. 14(4), pages 82-93.
    3. 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.
    4. Karen Benson & Barry Oliver, 2004. "Management Motivation for Using Financial Derivatives in Australia," Australian Journal of Management, Australian School of Business, vol. 29(2), pages 225-242, December.
    5. Pinghsun Huang & Harley E. Ryan & Roy A. Wiggins, 2007. "The Influence Of Firm- And Ceo-Specific Characteristics On The Use Of Nonlinear Derivative Instruments," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 30(3), pages 415-436.
    6. Gerald D. Gay & Jouahn Nam & Marian Turac, 2003. "On the optimal mix of corporate hedging instruments: Linear versus nonlinear derivatives," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 23(3), pages 217-239, March.
    7. René M. Stulz, 1996. "Rethinking Risk Management," Journal of Applied Corporate Finance, Morgan Stanley, vol. 9(3), pages 8-25.
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    Cited by:

    1. Dionne, Georges & Ouederni, Karima, 2011. "Corporate risk management and dividend signaling theory," Finance Research Letters, Elsevier, vol. 8(4), pages 188-195.
    2. Frestad, Dennis, 2010. "Corporate hedging under a resource rent tax regime," Energy Economics, Elsevier, vol. 32(2), pages 458-468, March.
    3. repec:bla:jrinsu:v:84:y:2017:i:4:p:1127-1169 is not listed on IDEAS
    4. Al-Shboul, Mohammad & Anwar, Sajid, 2014. "Foreign exchange rate exposure: Evidence from Canada," Review of Financial Economics, Elsevier, vol. 23(1), pages 18-29.
    5. Koziol, Philipp, 2014. "Inflation and interest rate derivatives for FX risk management: Implications for exporting firms under real wealth," The Quarterly Review of Economics and Finance, Elsevier, vol. 54(4), pages 459-472.

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