How do financial firms manage risk? Unraveling the interaction of financial and operational hedging

Kristine Watson Hankins

Research output: Contribution to journalArticlepeer-review

45 Scopus citations

Abstract

This paper investigates how firms manage risk by examining the relationship between financial and operational hedging using a sample of bank holding companies. Risk management theory holds that capital market imperfections make cash flow volatility costly. I investigate whether financial firms consider this cost or focus exclusively on managing tradable exposures. After documenting that acquisitions provide operational hedging by reducing potentially costly volatility, I find that postacquisition financial hedging declines even after controlling for the specific underlying risks. In addition, the decrease in financial hedging is related to the acquisition's level of operational hedging. Larger increases in operational hedging are followed by larger declines in financial hedging. These results indicate that firms in this sample manage aggregate risk, not just tradable exposures, and that operational hedging can substitute for financial hedging.

Original languageEnglish
Pages (from-to)2197-2212
Number of pages16
JournalManagement Science
Volume57
Issue number12
DOIs
StatePublished - Dec 2011

Keywords

  • Banks
  • Corporater finance
  • Finance
  • Financial institutions
  • Risk management

ASJC Scopus subject areas

  • Strategy and Management
  • Management Science and Operations Research

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