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Risk Measurement and Hedging: With and Without Derivatives, Financial Management

Abstract

This paper examines a setting where the two firms' derivative strategies are known but completely different. American Barrick aggressively hedges its gold price risk using derivatives, while Homestake Mining uses no derivatives. Instead they use a combination of operating and financial decisions to manage their risk. The different choice of methods is a result of different abilities to adjust operating costs and different needs for investment capital. Different investment strategies imply that Homestake Mining's capital needs are more highly correlated with gold prices, and thus cashflow hedging has less value. Managerial incentives also play a role. Although risk averse managers have an incentive to reduce risk, how and how much they hedge depends upon how they are compensated. The multitude of risk management methods used by similar firms means that tests of risk management theory must account for different opportunities and different objectives when examining firm's risk management strategies.

Type

Article

Author(s)

Mitchell A. Petersen, S.Ramu Thiagarajan

Date Published

2000

Citations

Petersen, A. Mitchell, and S.Ramu Thiagarajan. 2000. Risk Measurement and Hedging: With and Without Derivatives. Financial Management. 29(4): 5-29.

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