Abnormal Returns From Hedging, Firm Size, and the Fama and French Multifactor Models

Abstract

I use the Fama and French (2015) five-factor model to reexamine the seemingly anomalous result of Nelson, Moffitt, and Affleck-Graves (2005), who document significant positive abnormal returns for firms that hedge. Contrary to their results, using the five-factor model on a new sample of U.S. firms from 2013 – 2021, I observe significant negative monthly abnormal returns of -0.190% (-2.26% annually) for firms using derivative securities (hedgers). My result is consistent with poorly diversified managers engaging in costly hedging behavior that benefits management at the cost of shareholders. When I divide the sample by size (total assets), I find that the significant negative abnormal returns are confined only to large firms, offering no support for the economies of scale or managerial sophistication hypotheses.