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Hedging the Value of Waiting

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  • Boyle, Glenn
  • Guthrie, Graeme

Abstract

We analyze the optimal hedging policy of a firm that has flexibility in the timing of investment. Conventional wisdom suggests that hedging adds value by alleviating the underinvestment problem associated with capital market frictions. However our model shows that hedging also adds value by allowing investment to be delayed in circumstances where the same frictions would cause it to commence prematurely. Thus hedging can have the paradoxical effect of reducing investment. We also show that greater timing flexibility increases the optimal quantity of hedging but has a non-monotonic effect on the additional value created by hedging. These results may help explain the empirical findings that investment rates do not differ between hedgers and non-hedgers and that hedging propensities do not depend on standard measures of growth opportunities.

Suggested Citation

  • Boyle, Glenn & Guthrie, Graeme, 2006. "Hedging the Value of Waiting," Working Paper Series 18974, Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation.
    • Handle: RePEc:vuw:vuwcsr:18974
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