Option value at risk and the value of the firm: Does it pay to hedge?

Decisions to modify the firm's natural exposure by using derivatives should be referenced back to the maximisation of corporate value. Every firm has a natural exposure to adversity, costs that typically start well in advance of bankruptcy. The implicit value of the resulting adversity or hazard options extends a long shadow over corporate value, even in better states, and this is what hedging is designed to neutralise. The framework is used to integrate corporate value maximisation, value at risk and expected utility theory. Value at risk can be regarded as a socially imposed devise to neutralise the shareholders' limited liability exit option and will often result in over-hedging. It may be not optimal to hedge in adverse conditions: one should hedge the prospect but not the event. Modifiers such as leverage, exposure uncertainty, market incompleteness, competition and bank regulation can be explored within the same framework.