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A strategic approach to hedging and contracting

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This paper provides a new rationale for hedging that is based partly on noncompetitive behavior in product markets. The authors identify a set of conditions that imply that a firm may want to hedge. Empirically, these conditions are consistent with what is observed in the marketplace. The conditions are: 1) firms have some market power in their product market; 2) firms have limited liability; and 3) firms can contract to sell their output at a specified price before all factors that can affect their profitability are known. For some parameter specifications, however, the model predicts that firms will not want to hedge. This is important as the hedging results since, in practice, a large fraction of firms do hedge their cash flows, but a substantial number do not.

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  • David Downie & Ed Nosal, 2001. "A strategic approach to hedging and contracting," Working Papers (Old Series) 0119, Federal Reserve Bank of Cleveland.
    • Handle: RePEc:fip:fedcwp:0119
    DOI: 10.26509/frbc-wp-200119
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    1. Stulz, René M., 1984. "Optimal Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 19(2), pages 127-140, June.
    2. Allaz Blaise & Vila Jean-Luc, 1993. "Cournot Competition, Forward Markets and Efficiency," Journal of Economic Theory, Elsevier, vol. 59(1), pages 1-16, February.
    3. Vojislav Maksimovic, 1988. "Capital Structure in Repeated Oligopolies," RAND Journal of Economics, The RAND Corporation, vol. 19(3), pages 389-407, Autumn.
    4. Stulz, ReneM., 1990. "Managerial discretion and optimal financing policies," Journal of Financial Economics, Elsevier, vol. 26(1), pages 3-27, July.
    5. François Degeorge & B. Moselle & R.J. Zeckhauser, 1996. "Hedging and Gambling: Corporate Risk Choice When Informing the Market," Working Papers hal-00606074, HAL.
    6. DeMarzo, Peter M & Duffie, Darrell, 1995. "Corporate Incentives for Hedging and Hedge Accounting," The Review of Financial Studies, Society for Financial Studies, vol. 8(3), pages 743-771.
    7. 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.
    8. Graham, J.R. & Smith, Jr.C.W., 1996. "The Incentives to Hedge," Papers 96-03, Rochester, Business - Financial Research and Policy Studies.
    9. Brander, James A. & Lewis, Tracy R., 1986. "Oligopoly and Financial Structure: The Limited Liability Effect," American Economic Review, American Economic Association, vol. 76(5), pages 956-970, December.
    10. Ljungqvist Lars, 1994. "Asymmetric Information: A Rationale for Corporate Speculation," Journal of Financial Intermediation, Elsevier, vol. 3(2), pages 188-203, March.
    11. Blaise Allaz & Jean-Luc Vila, 1993. "Cournot Competition, Forward Markets and Efficiency," Post-Print hal-00511806, HAL.
    12. DeMarzo, Peter M. & Duffie, Darrell, 1991. "Corporate financial hedging with proprietary information," Journal of Economic Theory, Elsevier, vol. 53(2), pages 261-286, April.
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    1. Janne Kettunen & Eissa Nematollahi & Yuriy Zinchenko, 2022. "Why do Energy Markets in Europe Rely on One Instrument?," Production and Operations Management, Production and Operations Management Society, vol. 31(4), pages 1473-1491, April.
    2. Marcello Spanò, 2013. "Theoretical explanations of corporate hedging," International Journal of Business and Social Research, MIR Center for Socio-Economic Research, vol. 3(7), pages 84-102, July.
    3. Marcello Spanò, 2013. "Theoretical explanations of corporate hedging," International Journal of Business and Social Research, LAR Center Press, vol. 3(7), pages 84-102, July.

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    Hedging (Finance);

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