Corporate hedging and the variance of stock returns

Abstract

By means of a difference-in-differences approach on the volatility of stock returns (σ-DID), we investigate the effect that hedging has on corporate risk. Examining the relation between hedging and the idiosyncratic variance of stock returns, we show that when new commodity derivatives are introduced in the Chicago Mercantile Exchange (CME), firms with exposure to the commodities experience up to a 40% drop in the idiosyncratic variance of stock returns. The effect is persistent over time and it is associated with real effects: firms that hedge more also experience an increase in profit margins, investment, access to credit lines, and a drop in cash holdings. Our results establish a direct link between corporate risk management policies and stock return behavior.