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Title: Are there speculative components in corporate hedging and do they add value?
Authors: Adam, Tim R.
Fernando, Chitru S.
Keywords: Risk management
Risk premium
Selective hedging
Market timing
Issue Date: Feb-2003
Abstract: Why does corporate risk management add value? A common hypothesis is that derivatives transactions have zero NPV, and add value only because they help firms mitigate market imperfections. We reexamine this question by analyzing the derivatives transactions of 92 North American gold mining firms from 1989-1999. Our data allows us to infer the quarterly cash flows that each firm derives specifically from its derivatives transactions. Surprisingly, we find that these cash flows are positive, and both economically and statistically significant. Our sample firms realized an average gain of $2.73 million per quarter from their derivatives transactions, while their average quarterly net income was only $0.87 million. These gains appear to be the result of systematic positive risk premia in the gold market. Furthermore, we find evidence that is consistent with firms incorporating their market views into their hedging programs. However, we find that speculating on the time variation of the risk premium has not created any value for shareholders on average. To our knowledge, ours is the first study to show that corporate derivatives usage can be intrinsically valuable, and our results highlight a potentially important motive for the corporate use of derivatives that the literature has hitherto ignored.
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