IDEAS home Printed from https://ideas.repec.org/p/cpr/ceprdp/4755.html
   My bibliography  Save this paper

Liquidity Risk and Corporate Demand for Hedging and Insurance

Author

Listed:
  • Rochet, Jean-Charles
  • Villeneuve, Stéphane

Abstract

We analyse the demand for hedging and insurance by a firm that faces liquidity risk. The firm's optimal liquidity management policy consists of accumulating reserves up to a threshold and distributing dividends to its shareholders whenever its reserves exceed this threshold. We study how this liquidity management policy interacts with two types of risk: a Brownian risk that can be hedged through a financial derivative, and a Poisson risk that can be insured by an insurance contract. We find that the patterns of insurance and hedging decisions as a function of liquidity are poles apart: cash-poor firms should hedge but not insure, whereas the opposite is true for cash-rich firms. We also find non-monotonic effects of profitability and leverage. This may explain the mixed findings of empirical studies on corporate demand for hedging and insurance.

Suggested Citation

  • Rochet, Jean-Charles & Villeneuve, Stéphane, 2004. "Liquidity Risk and Corporate Demand for Hedging and Insurance," CEPR Discussion Papers 4755, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:4755
    as

    Download full text from publisher

    File URL: http://www.cepr.org/active/publications/discussion_papers/dp.php?dpno=4755
    Download Restriction: CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. 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.
    2. Bruno Jullien & Georges Dionne & Bernard Caillaud, 2000. "Corporate insurance with optimal financial contracting," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 16(1), pages 77-105.
    3. M. Martin Boyer, 2003. "Is the Demand for Corporate Insurance a Habit? Evidence from Directors' and Officers' Insurance," CIRANO Working Papers 2003s-42, CIRANO.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Anderson, Ronald W. & Carverhill, Andrew, 2005. "A Model of Corporate Liquidity," CEPR Discussion Papers 4994, C.E.P.R. Discussion Papers.
    2. Léautier, Thomas-Olivier & Rochet, Jean-Charles, 2014. "On the strategic value of risk management," International Journal of Industrial Organization, Elsevier, vol. 37(C), pages 153-169.
    3. Jean-Paul Décamps & Stéphane Villeneuve, 2007. "Optimal dividend policy and growth option," Finance and Stochastics, Springer, vol. 11(1), pages 3-27, January.
    4. Anderson, Ronald W. & Carverhill, Andrew, 2006. "Liquidity and capital structure," LSE Research Online Documents on Economics 24632, London School of Economics and Political Science, LSE Library.
    5. Yann Braouezec & Charles-Albert Lehalle, 2010. "Corporate Liquidity, Dividend Policy And Default Risk: Optimal Financial Policy And Agency Costs," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 13(04), pages 537-576.
    6. Dionne, Georges & Santugini, Marc, 2014. "Entry, imperfect competition, and futures market for the input," International Journal of Industrial Organization, Elsevier, vol. 35(C), pages 70-83.
    7. Anderson, Ronald W. & Carverhill, Andrew, 2007. "Liquidity and Capital Structure," CEPR Discussion Papers 6044, C.E.P.R. Discussion Papers.
    8. Nataliya Klimenko, 2013. "Tailoring Bank Capital Regulation for Tail Risk," Working Papers halshs-00796490, HAL.
    9. Anderson, Ronald W. & Carverhill, Andrew, 2005. "A model of corporate liquidity," LSE Research Online Documents on Economics 24643, London School of Economics and Political Science, LSE Library.
    10. Nataliya Klimenko, 2013. "Tailoring Bank Capital Regulation for Tail Risk," AMSE Working Papers 1310, Aix-Marseille School of Economics, Marseille, France, revised Feb 2013.
    11. Jean-Charles Rochet & Stéphane Villeneuve, 2005. "Corporate portfolio management," Annals of Finance, Springer, vol. 1(3), pages 225-243, August.
    12. Gatopoulos, Georgios & Loubergé, Henri, 2013. "Combined use of foreign debt and currency derivatives under the threat of currency crises: The case of Latin American firms," Journal of International Money and Finance, Elsevier, vol. 35(C), pages 54-75.

    More about this item

    Keywords

    corporate hedging; liquidity risk; risk management;

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:cpr:ceprdp:4755. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.