A new look at hedging with derivatives: Will firms reduce market risk exposure?

Abstract

This study examines derivatives use of foreign exchange, interest rate, and commodities risk by nonfinancial firms across multiple industries, using data from 1995 to 2001. This work considers the interaction of a firm's risk exposures, derivatives use, and real operations simultaneously, and considers how these factors change over time using a consistent data-base. Hedging with derivatives is only significantly related to commodity risk exposure during most years of the study, and to a more limited degree to interest rate exposure. Further, a strong correlation was found between risk exposures for some years using a new technique, suggesting that univariate modeling is not always appropriate. The implications are that hedging with derivatives is not always important to a firm's rate of return and is linked to other nonfinancial and economic factors. © 2007 Wiley Periodicals, Inc.