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How should firms selectively hedge? Resolving the selective hedging puzzle

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  • Wojakowski, Rafał M.

Abstract

We provide a model of intertemporal hedging consistent with selective hedging, a widespread practice corroborated by recent empirical studies. We argue that the optimal hedge is a value hedge involving total current value of future earnings. More importantly, the hedging decision is independent of risk preferences of the firm or agent. Our closed-form solutions imply several implications for the risk management policy in a firm. In order to lock in profits a hedge increase is recommended in favorable states of nature, while in bad states the firm should decrease the hedge and wait. Our main new empirical implication is that selective hedging should be more prevalent in industries where managers are exposed to convex cash flow structures and are more likely to “value hedge” their exposures.

Suggested Citation

  • Wojakowski, Rafał M., 2012. "How should firms selectively hedge? Resolving the selective hedging puzzle," Journal of Corporate Finance, Elsevier, vol. 18(3), pages 560-569.
    • Handle: RePEc:eee:corfin:v:18:y:2012:i:3:p:560-569
    DOI: 10.1016/j.jcorpfin.2012.02.003
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    References listed on IDEAS

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    4. Kim, Huong Trang & Papanastassiou, Marina & Nguyen, Quang, 2017. "Multinationals and the impact of corruption on financial derivatives use and firm value: Evidence from East Asia," Journal of Multinational Financial Management, Elsevier, vol. 39(C), pages 39-59.

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    More about this item

    Keywords

    Selective hedging; Value hedge; Financial forwards and futures; Long-term exposure;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General

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