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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
Affiliation:
Lancaster University, Management School, Lancaster LA1 4YX, United Kingdom, and State Street Global Advisors, s.m.bartram@lancaster.ac.uk
Gregory W. Brown
Affiliation:
gregwbrown@unc.edu
Jennifer Conrad
Affiliation:
Kenan-Flagler Business School, University of North Carolina at Chapel Hill, CB 3490, Chapel Hill, NC 27599, j_conrad@unc.edu

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
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2011

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