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Corporate Hedging and Speculative Incentives: Implications for Swap Market Default Risk

  • Mozumdar, Abon
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    This paper demonstrates a tradeoff between the risk-shifting and hedging incentives of firms and identifies conditions under which each dominates. A firm may have the incentive to hedge in a multi-period context, even if no such incentive exists in a single-period one. Unrestricted access to swaps in the presence of asymmetric information about firm type and the swapping motive would lead to unbounded speculation resulting in breakdowns in swap and debt markets. Price-based methods are unable to control this and market makers have to rely upon additional exposure information or credit enhancement devices to preserve equilibrium.

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    Article provided by Cambridge University Press in its journal Journal of Financial and Quantitative Analysis.

    Volume (Year): 36 (2001)
    Issue (Month): 02 (June)
    Pages: 221-250

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    Handle: RePEc:cup:jfinqa:v:36:y:2001:i:02:p:221-250_00
    Contact details of provider: Postal: Cambridge University Press, UPH, Shaftesbury Road, Cambridge CB2 8BS UK
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