Why Most Firms Choose Linear Hedging Strategies

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.”