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The Two Sides of Derivatives Usage: Hedging and Speculating with Interest Rate Swaps

Published online by Cambridge University Press:  01 June 2011

Sergey Chernenko
Affiliation:
Fisher College of Business, Ohio State University, 818 Fisher Hall, Columbus, OH 43210. sergey.chernenko@fisher.osu.edu
Michael Faulkender
Affiliation:
Smith School of Business, University of Maryland, 4411 Van Munching Hall, College Park, MD 20742. mfaulken@rhsmith.umd.edu
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Abstract

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Existing cross-sectional findings on nonfinancial firms’ use of derivatives that are usually interpreted as the result of hedging may alternatively be due to speculation. Panel data examinations can distinguish between derivatives practices that endure over time and are therefore more likely to result from hedging, and those that are more transient, thus more consistent with speculation. Our decomposition results indicate that hedging of interest rate risk is concentrated among high-investment firms, consistent with costly external finance. Simultaneously, firms appear to use interest rate swaps to manage earnings and to speculate when their executive compensation contracts are more performance sensitive.

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

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