A New Look at Hedging with Derivatives: Will Firms Reduce Market Risk Exposure?

Abstract

This paper examines derivatives use of foreign exchange, interest rate and commodities risk by non-financial firms across multiple industries, using data from 1995 to 2001. This paper 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, we find a strong correlation 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 non-financial and economic factors.