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| Author: | Brown, G. W. Toft, K. B. |
| Title: | How Firms Should Hedge |
| Journal: | Review of Financial Studies
2002 : FALL, VOL. 15:4, p. 1283-1324 |
| Index terms: | COMPANIES HEDGING MODELS STRATEGY |
| Language: | eng |
| Abstract: | Substantial academic research explains why firms should hedge, but little work has addressed how firms should hedge. The authors assume that firms can experience costly states of nature and derive optimal hedging strategies using vanilla derivatives (e.g., forwards and options) and custom "exotic" derivative contracts for a value-maximizing firm facing both hedgable (price) and unhedgable (quantity) risks. Customized exotic derivatives are typically better than vanilla contracts when correlations between prices and quantities are large in magnitude and when quantity risks are substantially greater than price risks. Finally, the authors discuss how the authors' model may be applied in practice. |
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