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Optimal hedge ratio in a biased forward market under liquidity constraints

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  • Dömötör, Barbara

Abstract

The paper1 investigates corporate hedging behavior in a theoretical model focusing on two important influencing factors: liquidity constraints affecting the funding opportunity of the firm and the extent of available hedging position, and speculative motive of risk management based on a bias of forward market. The optimal hedge ratio is analyzed in the function of three determining factors of the corporate utility function: the risk aversion ratio of the firm, the expected value of the hedge position, and the financing costs due to the hedging itself. The large empirical evidence of corporate over- and underhedge can be better understood in the presented framework.

Suggested Citation

  • Dömötör, Barbara, 2017. "Optimal hedge ratio in a biased forward market under liquidity constraints," Finance Research Letters, Elsevier, vol. 21(C), pages 259-263.
  • Handle: RePEc:eee:finlet:v:21:y:2017:i:c:p:259-263
    DOI: 10.1016/j.frl.2016.11.009
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    References listed on IDEAS

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    1. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    2. Stewart C. Myers & Nicholas S. Majluf, 1984. "Corporate Financing and Investment Decisions When Firms Have InformationThat Investors Do Not Have," NBER Working Papers 1396, National Bureau of Economic Research, Inc.
    3. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June.
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    5. Ehsani, Sina & Lien, Donald, 2015. "A note on minimum riskiness hedge ratio," Finance Research Letters, Elsevier, vol. 15(C), pages 11-17.
    6. Rampini, Adriano A. & Sufi, Amir & Viswanathan, S., 2014. "Dynamic risk management," Journal of Financial Economics, Elsevier, vol. 111(2), pages 271-296.
    7. Hossfeld, Oliver & Röthig, Andreas, 2016. "Do speculative traders anticipate or follow USD/EUR exchange rate movements? New evidence on the efficiency of the EUR currency futures market," Finance Research Letters, Elsevier, vol. 18(C), pages 218-225.
    8. Edina Berlinger & Kata Váradi, 2015. "Risk Appetite," Public Finance Quarterly, State Audit Office of Hungary, vol. 60(1), pages 49-62.
    9. Smith, Clifford W. & Stulz, René M., 1985. "The Determinants of Firms' Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(04), pages 391-405, December.
    10. Froot, Kenneth A & Scharfstein, David S & Stein, Jeremy C, 1993. " Risk Management: Coordinating Corporate Investment and Financing Policies," Journal of Finance, American Finance Association, vol. 48(5), pages 1629-1658, December.
    11. Stefan Avdjiev & Wenxin Du & Catherine Koch & Hyun Song Shin, 2016. "The dollar, bank leverage and the deviation from covered interest parity," BIS Working Papers 592, Bank for International Settlements.
    12. Holthausen, Duncan M, 1979. "Hedging and the Competitive Firm under Price Uncertainty," American Economic Review, American Economic Association, vol. 69(5), pages 989-995, December.
    13. Jean Tirole, 2006. "The Theory of Corporate Finance," Post-Print hal-00173191, HAL.
    14. René M. Stulz, 1996. "Rethinking Risk Management," Journal of Applied Corporate Finance, Morgan Stanley, vol. 9(3), pages 8-25.
    15. Rolfo, Jacques, 1980. "Optimal Hedging under Price and Quantity Uncertainty: The Case of a Cocoa Producer," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 100-116, February.
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    More about this item

    Keywords

    Corporate risk management; Optimal hedge ratio; Funding liquidity; Biased forward markets;

    JEL classification:

    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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