Who hedges more when leverage is endogenous? A testable theory of corporate risk management under general distributional conditions

Lutz Hahnenstein () and Klaus Röder

Review of Quantitative Finance and Accounting, 2007, vol. 28, issue 4, 353-391

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 bankruptcy cost functions, will choose higher hedge ratios. Moreover, we suggest a new approach to test this relationship empirically. Copyright Springer Science+Business Media, LLC 2007

Keywords: Corporate hedging; Risk management; Leverage; Capital structure; Bankruptcy; Financial distress; G32; G39 (search for similar items in EconPapers)
Date: 2007
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Citations: View citations in EconPapers (6)

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DOI: 10.1007/s11156-007-0017-z

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