Corporate risk management and speculative motives

Gregory W. Brown, Zeigham I. Khokher

Abstract

ABSTRACT

We develop a simple framework for analyzing corporate risk management decisions when managers have a directional prediction on future price levels. The optimal hedging strategy with “a view” retains a partial exposure and requires rebalancing. This can help explain the active trading behavior of some managers, the large cross-sectional and time series variation in hedge ratios and the prevalence of partial hedging. In addition to providing a simple account of the stylized facts, the model generates new testable implications for corporate hedging policy. We parameterize and estimate the model using foreign exchange hedging data from a large multinational corporation and find support for the model’s predictions.