2007
DOI: 10.1007/s11156-007-0017-z
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Who hedges more when leverage is endogenous? A testable theory of corporate risk management under general distributional conditions

Abstract: This paper develops a theory of a firm’s hedging decision with endogenous leverage. In contrast to previous models in the literature, our framework is based on less restrictive distributional assumptions and allows a closed-form analytical solution to the joint optimization problem. Using anecdotal evidence of greater benefits of risk management for firms selling “credence goods” or products that involve long-term relationships, we prove that those optimally leveraged firms, which face more convex indirect ban… Show more

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Cited by 8 publications
(3 citation statements)
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“…As a counterweight to FDC that prevents firms from transferring 100% of its hedgeable risk to the financial markets, we introduce transaction costs TC into the model, cf. Hahnenstein and Röder (2007) for a hedging model with transaction costs. The transaction cost function we assume is TC=γV0σσ,where σ denotes the optimal firm value volatility after hedging.…”
Section: Modelling Frameworkmentioning
confidence: 99%
“…As a counterweight to FDC that prevents firms from transferring 100% of its hedgeable risk to the financial markets, we introduce transaction costs TC into the model, cf. Hahnenstein and Röder (2007) for a hedging model with transaction costs. The transaction cost function we assume is TC=γV0σσ,where σ denotes the optimal firm value volatility after hedging.…”
Section: Modelling Frameworkmentioning
confidence: 99%
“…As proposed by several authors, firms might jointly make decisions concerning corporate hedging, financing, and investment (among others, Froot et al 1993;Hahnenstein and Röder 2007;Lin et al 2008;Ross 1977). In this context, multiple studies argue that corporate hedging activities have a positive influence on leverage (Graham and Rogers 2002;Leland 1998;Lin et al 2008;Stulz 1996).…”
Section: Financing and Investmentmentioning
confidence: 99%
“…The current specification of deadweight costs makes sense when these costs are primarily driven by firm value (Hahnenstein & Röder, 2007;Merton, 1973Merton, , 1974. However, if costly cash shortfall is the key constituent of deadweight costs in the spirit of Froot and Stein (1993), a more cash-flow oriented approach is appropriate.…”
Section: Proposition 2: Consider Firms That Face Deadweight Costs In mentioning
confidence: 99%