Working Paper

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


Abstract: Risk management is the most widely-cited reason that non-financial corporations use derivatives. If hedging programs are effective, then firms using derivatives should have lower credit risk than those that do not. Surprisingly, we find that firms with derivative positions without a hedge accounting designation (typically higher basis risk) have higher CDS spreads than firms that do not hedge at all. We do not find evidence that these non-designated positions are associated with future credit realizations. We examine alternative explanations and find evidence that is consistent with a market penalty for high basis risk positions when overall market conditions are poor.

Keywords: Counterparty credit risk; Derivatives, futures, and options; Risk management; Hedging;

https://doi.org/10.17016/FEDS.2016.100

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Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2016-07-20

Number: 2016-100