Are Corporations Reducing or
Taking Risks with Derivatives?
Ludger Hentschela and S.P. Kotharib
aSimon School, University of Rochester, Rochester, NY 14627.
bSloan School, Massachusetts Institute of Technology, Cambridge, MA 02142.
February 17, 2001
First Draft: August 1994
Forthcoming in Journal of Financial and Quantitative Analysis, March 2001
Comments Welcome
Abstract: Public discussion about corporate use of derivatives focuses on
whether firms use derivatives to reduce or increase firm risk. In contrast, em-
pirical, academic studies of corporate derivatives-use take it for granted that
firms hedge with derivatives. Using data from financial statements of 425 large
u.s. corporations, we investigate whether firms systematically reduce or increase
their riskiness with derivatives. We find that many firms manage their exposures
with large derivatives positions. Nonetheless, compared to firms that do not use
financial derivatives, firms that use derivatives display few, if any, measurable
differences in risk that are associated with the use of derivatives.
Keywords: Derivatives, futures, forwards, hedging, options, risk management,
speculation, swaps.
JEL Classifications: G32, M41
We thank the following for helpful comments: an anonymous referee, Paul Gompers, Stacey
Kole, John Long, Bill Schwert, Jay Shanken, CliffSmith and seminar participants at the
Berkeley Program in Finance, the cepr Summer Symposium in Finance, the Chicago Board
of Trade, the inquire Conference, and the London School of Economics. Anjali Arora and
Eric Kim (under an Olin Fellowship) provided excellent research assistance. We gratefully
acknowledge financial support from the Bradley Policy Research Center and the John M. Olin
Foundation.
Contents
1
Introduction
1
2 Derivative Holdings and Firm Characteristics
3
2.1 Disclosure of Derivative Activity in Financial Reports .
.
.
.
.
3
2.2 Sample Construction
. .
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
4
2.3 Derivatives Held by Sample Firms . .
.
.
.
.
.
.
.
.
.
.
.
.
5
2.4 Financial Characteristics