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Corporate Hedging and SpeculativeIncentives: Implications for Swap Market DefaultRisk

Published online by Cambridge University Press:  06 April 2009

Abon Mozumdar
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Abstract

This paper demonstrates a tradeoff between therisk-shifting and hedging incentives of firms andidentifies conditions under which each dominates. Afirm may have the incentive to hedge in amulti-period context, even if no such incentiveexists in a single-period one. Unrestricted accessto swaps in the presence of asymmetric informationabout firm type and the swapping motive would leadto unbounded speculation resulting in breakdowns inswap and debt markets. Price-based methods areunable to control this and market makers have torely upon additional exposure information or creditenhancement devices to preserve equilibrium.

Information

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 36 , Issue 2 , June 2001 , pp. 221 - 250
Copyright
Copyright © School of Business Administration, University of Washington 2001

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Footnotes

*

Pamplin College of Business, Virginia Tech, 1016Pamplin Hall-0221, Blacksburg, VA 24061. Thispaper is based on a chapter entitled “Swaps,Default Risk and the Corporate Hedging Motive”from my Ph.D. dissertation at New York University.I am grateful to Hendrik Bessembinder (associateeditor and referee) for exceptionally constructivecomments, Jonathan Karpoff (the editor), YakovAmihud, Don Chance, Zsuzsanna Fluck, Kose John,Authony Lynch, N. R. Prabhala, Anthony Saunders,Cliff Smith, Raghu Sundaram, Robert Whitelaw, andseminar participants at New York University andVirginia Tech for comments and suggestions. Iespecially thank Marti Subrahmanyam for guidance,suggestions, and encouragement. Financial supportfrom a summer research grant at Virginia Tech isgratefully acknowledged. I am solely responsiblefor any remaining errors.

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