Summary of Does Hedging with Derivatives Reduce the Market’s Perception of Credit Risk?

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Does Hedging with Derivatives Reduce the Market’s Perception of Credit Risk? summary
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Warren Buffett has famously characterized derivatives as “financial weapons of mass destruction.” That almost proved to be the case when their use in the run-up to the 2008 financial crisis threatened to bring down the global economy. But derivatives also can mitigate firm risk. Economists Sriya Anbil, Alessio Saretto and Heather Tookes examine whether the market imposes a penalty on companies that don’t use their hedge positions for purely financial management purposes. Although technical, their report contains some good input that getAbstract expects financial managers and investors will find useful.

In this summary, you will learn

  • What impact a firm’s use of derivatives has on its credit spreads,
  • Why the market differentiates between a company’s use of derivatives for hedging and nonhedging purposes, and
  • What accounts for this market distinction.
 

About the Authors

Sriya Anbil is an economist with the Board of Governors of the Federal Reserve. Alessio Saretto is an assistant professor of finance at the University of Texas at Dallas. Heather Tookes is a professor of finance at the Yale School of Management.

 

Summary

Nonfinancial firms use derivatives not only to manage their risk exposures but also for speculative purposes. When hedges help offset an underlying asset risk, they get favorable treatment under US accounting rules, which allow companies to forgo marking those derivatives to market, thus avoiding earnings...

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