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The Effects of Derivatives on Firm Risk and Value

Published online by Cambridge University Press:  17 May 2011

Söhnke M. Bartram ,
Gregory W. Brown  and
Jennifer Conrad
Söhnke M. Bartram
Affiliation:
Lancaster University, Management School, Lancaster LA1 4YX, United Kingdom, and State Street Global Advisors, [email protected]
Gregory W. Brown
Affiliation:
[email protected]
Jennifer Conrad
Affiliation:
Kenan-Flagler Business School, University of North Carolina at Chapel Hill, CB 3490, Chapel Hill, NC 27599, [email protected]
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Abstract

Using a large sample of nonfinancial firms from 47 countries, we examine the effect of derivative use on firm risk and value. We control for endogeneity by matching users and nonusers on the basis of their propensity to use derivatives. We also use a new technique to estimate the effect of omitted variable bias on our inferences. We find strong evidence that the use of financial derivatives reduces both total risk and systematic risk. The effect of derivative use on firm value is positive but more sensitive to endogeneity and omitted variable concerns. However, using derivatives is associated with significantly higher value, abnormal returns, and larger profits during the economic downturn in 2001–2002, suggesting that firms are hedging downside risk.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 46 , Issue 4 , August 2011 , pp. 967 - 999
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2011

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