Hedging operating and financing risk with financial derivatives during the global financial crisis

Abstract

We investigate whether firms properly protect values from sudden exchange rate changes using financial derivatives. Sampling Korean firms, we compare firms experiencing significant changes in exchange rate exposures to firms experiencing no such changes surrounding the global financial crisis. We find that the former outnumbers the latter, uses more derivatives for hedging, and has lower firm values. We further show that the lower firm values are more pronounced for firms hedging financing risk than firms hedging operating risk with derivatives, indicating more difficulty of hedging financing risk in the face of a sharp depreciation of local currency during the crisis.

Analyzing the Relationship Between Derivative Usage and Systemic Risk in South Africa

“…In other empirical studies, the direct impact of derivatives on economic performance has been explored, both at the firm and country levels (Jankensgard and Moursli, 2020, Bae and Kwon, 2020, Kim et al 2017, Vo et al 2020, Lazovy and Sipko, 2014. Bae and Kwon (2020) and Kim et al (2017) investigate the impact of derivative usage on firm value in Korea and a group of East Asian economies respectively. Bae and Kwon (2020) show that firms experiencing significant changes in exchange rate exposures use more derivatives and have lower firm value.…”

“…Bae and Kwon (2020) and Kim et al (2017) investigate the impact of derivative usage on firm value in Korea and a group of East Asian economies respectively. Bae and Kwon (2020) show that firms experiencing significant changes in exchange rate exposures use more derivatives and have lower firm value. On the other hand, Kim et al (2017) find derivative use as a value-enhancing activity for domestic firms and domestic multinational corporations (MNCs).…”

“…Theoretical arguments against the proposition of increased firm value arise from the notion of derivatives being speculative and opaque instruments, which can be used by financial corporations to undertake speculative positions to the detriment of financial market stability and societal welfare (LiPuma and Lee, 2004). Bae and Kwon (2020) also find that derivative hedging becomes difficult during times of crisis, hence increased derivative usage may result in decreased firm value and increased financial market fragility.…”