 HOW FIRMS MANAGE RISK: THE OPTIMAL MIX OF LINEAR AND NON‐LINEAR DERIVATIVESGerald D. Gay, Jouahn Nam and Marian Turac Journal of Applied Corporate Finance, 2002, vol. 14, issue 4, 82-93 Abstract: This paper provides guidance on how corporations should choose the optimal mix of “linear” and “non‐linear” derivatives. Linear derivatives are products such as futures, forwards, and swaps, whose payoffs vary in linear fashion with changes in the un‐derlying asset price or reference rate. Non‐linear derivatives are contracts with option‐like payoffs, including caps, floors, and swaptions. A company's optimal hedging position should generally consist of linear contracts because of their effective‐ness in smoothing corporate cash flows. But as the firm's business (quantity) risk increases, its use of linear contracts will decline due to costs associated with overhedging. At the same time, there will be a shift towards the use of non‐linear contracts. The degree of substitution of non‐linear for linear in‐struments will depend on the relation‐ship between the quantities to be hedged and market prices. A negative relationship will tend to exacerbate the substitution effect while a positive re‐lationship will dampen the effect. An empirical examination of corporate derivative holdings provides support for all of the major hypotheses. Date: 2002 Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:bla:jacrfn:v:14:y:2002:i:4:p:82-93 Ordering information: This journal article can be ordered from Access Statistics for this article Journal of Applied Corporate Finance is currently edited by Donald H. Chew Jr. More articles in Journal of Applied Corporate Finance from Morgan Stanley |
Is your work missing from RePEc? Here is how to contribute.
Questions or problems? Check the EconPapers FAQ or send mail to .
EconPapers is hosted by the
School of Business at Örebro University.