Featured Research

from universities, journals, and other organizations

Not so 'evil': Finance study makes case for hedging

Date:
January 31, 2014
Source:
Michigan State University
Summary:
Business researchers have come up with the first scientific evidence that hedging against risk can increase a firm's value.

The overuse of financial contracts known as derivatives -- which were designed to help companies hedge against risk -- was widely blamed for triggering the economic crisis of 2008. None other than Warren Buffet has attacked derivatives as "time bombs -- both for the parties that deal in them and the economic system."

Related Articles


But now, for the first time, researchers have found that hedging can increase firm value.

In a pioneering study published in the Journal of Finance, Michigan State University's Hayong Yun and Stanford University's Francisco Pιrez-Gonzαlez show that electric and gas utilities that used derivatives to hedge against unpredictable weather experienced a "positive and significant effect" on the value of their firms.

"Many people have a perception that derivatives are evil, that they helped destroy the economy," said Yun, MSU assistant professor of finance. "And while there is some truth to the argument that derivatives were overused, our research provides the first fundamental evidence that hedging with derivatives can improve company value."

Derivatives are widely used in the corporate world -- from a CEO's stock options to corn futures, in which a cereal maker, for example, purchases 2,500 corn bushels from a farmer at current prices for delivery in three months. Mortgage-backed securities, another type of derivative, were blamed for creating the housing bubble and subsequent recession.

Yun said he's not advocating that derivatives be completely deregulated. But at the same time, his research suggests derivatives -- when used wisely -- have an upside and should not be discounted as a potential instrument for company growth.

In the study, the researchers examined the value of publicly traded electric and gas utilities in the United States both before and after a weather derivatives market opened in the late 1990s. The market allowed the utilities to sell weather futures to investors.

Before the market opened, utility companies that were susceptible to unpredictable weather -- such as those in the Midwest -- were valued 3 percent to 4 percent lower, on average, than utilities where the weather was more stable, such as in southern California and Texas.

After the weather derivative market opened, that difference disappeared. Investors no longer cared the utility was located in an unstable-weather locale. In essence, the use of derivatives leveled the playing field, and utilities in the Midwest and other areas with unstable weather had equal value to those in stable-weather areas, as well as increased leverage and investments.


Story Source:

The above story is based on materials provided by Michigan State University. Note: Materials may be edited for content and length.


Cite This Page:

Michigan State University. "Not so 'evil': Finance study makes case for hedging." ScienceDaily. ScienceDaily, 31 January 2014. <www.sciencedaily.com/releases/2014/01/140131130805.htm>.
Michigan State University. (2014, January 31). Not so 'evil': Finance study makes case for hedging. ScienceDaily. Retrieved November 28, 2014 from www.sciencedaily.com/releases/2014/01/140131130805.htm
Michigan State University. "Not so 'evil': Finance study makes case for hedging." ScienceDaily. www.sciencedaily.com/releases/2014/01/140131130805.htm (accessed November 28, 2014).

Share This


More From ScienceDaily



More Computers & Math News

Friday, November 28, 2014

Featured Research

from universities, journals, and other organizations


Featured Videos

from AP, Reuters, AFP, and other news services

Recharge Your Phone in 30 Seconds? Israeli Firm Says It Can

Recharge Your Phone in 30 Seconds? Israeli Firm Says It Can

Reuters - Innovations Video Online (Nov. 28, 2014) — With consumers demanding more and more from their mobile devices, scientists in Israel and Singapore are developing super fast-charging batteries to power them. Amy Pollock has more. Video provided by Reuters
Powered by NewsLook.com
EU Pushes Google For Worldwide Right To Be Forgotten

EU Pushes Google For Worldwide Right To Be Forgotten

Newsy (Nov. 27, 2014) — Privacy regulators recommend Google expand its requested removals to apply to all its web domains. Video provided by Newsy
Powered by NewsLook.com
Predictions Of Tablets' Demise Sound Familiar

Predictions Of Tablets' Demise Sound Familiar

Newsy (Nov. 26, 2014) — The tablet's days are numbered, at least according to a recent IDC report. The market-research firm paints a grim outlook for tablets. Video provided by Newsy
Powered by NewsLook.com
Today's Prostheses Are More Capable Than Ever

Today's Prostheses Are More Capable Than Ever

Newsy (Nov. 26, 2014) — Advances in prosthetics are making replacement body parts stronger and more lifelike than they’ve ever been. Video provided by Newsy
Powered by NewsLook.com

Search ScienceDaily

Number of stories in archives: 140,361

Find with keyword(s):
 
Enter a keyword or phrase to search ScienceDaily for related topics and research stories.

Save/Print:
Share:  

Breaking News:

Strange & Offbeat Stories

 

Space & Time

Matter & Energy

Computers & Math

In Other News

... from NewsDaily.com

Science News

Health News

Environment News

Technology News



Save/Print:
Share:  

Free Subscriptions


Get the latest science news with ScienceDaily's free email newsletters, updated daily and weekly. Or view hourly updated newsfeeds in your RSS reader:

Get Social & Mobile


Keep up to date with the latest news from ScienceDaily via social networks and mobile apps:

Have Feedback?


Tell us what you think of ScienceDaily -- we welcome both positive and negative comments. Have any problems using the site? Questions?
Mobile iPhone Android Web
Follow Facebook Twitter Google+
Subscribe RSS Feeds Email Newsletters
Latest Headlines Health & Medicine Mind & Brain Space & Time Matter & Energy Computers & Math Plants & Animals Earth & Climate Fossils & Ruins