Essays on the Risk-averse Behavior: Empirical Evidence on the Motivation for Derivatives Hedging and Its Impact

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Title:	Essays on the Risk-averse Behavior: Empirical Evidence on the Motivation for Derivatives Hedging and Its Impact
Other Titles:	Essays on the Risk-averse Behavior: Empirical Evidence on the Motivation for Derivatives Hedging and Its Impact
Authors:	辛奕成 Shin, Yi-Cheng
Contributors:	許永明 Shiu, Yung-Ming 東海大學國際貿易學系
Keywords:	Derivatives;Risk management;Hedging;Speculation
Date:	2006
Issue Date:	2011-04-07T05:53:36Z (UTC)
Abstract:	With further liberalization of Taiwanese financial market since the early 1990s, the financial intermediaries have more exposed themselves to higher capital market risks, such as currency and interest rate fluctuations. On-balance sheet hedging instruments available to managers could not be employed to effectively minimize firm risk, while the derivatives hedging devises provide alternative ways of managing risks arising from various types of price movements. In the recent past, the dramatic surge in the trading volume of off-balance-sheet contracts suggests that the derivatives instruments are widely used for reducing firm-specific risk. Therefore, it would be noteworthy to examine the motivation for and the influence of derivatives hedging.This thesis consists of two chapters. In the first chapter, due to the availability of market information on firm value and the derivatives data provided by the Central Bank, we identify the above mentioned issues through the probit and panel regressions using a panel database of 934 bank-quarter observations. Based on the first model results, we find that banks exposed to higher interest rate and currency risks are more likely to use derivatives for risk management. Firm size and holding company affiliation also affect banks’ participation in derivatives activities. Further, we evidence that the unaffiliated bank, albeit with a higher tendency to use derivatives, has lower involvement in the extent of derivatives hedging since the derivatives market is dominated by the affiliated banks that face risk exposures great enough to make derivatives activities worthwhile. Debt-constrained banks relying on preferred stock financing are found to use derivatives to hedge against potentially financial distress costs. In addition, we also find that the diversification of cash flows from operating activities and the diversified portfolio in long-term investment and debt positions seem to serve as substitutes for hedging. The results obtained from the second model are consistent with the findings of prior literature. The use of derivatives for risk reduction is weakly supported in our study by the extent of participation in interest rate-related contracts. However, as evidenced by the positive relationship, banks’ participation in currency derivatives might be speculative and slightly enhance the level of total risk and unsystematic risk.The second chapter investigates the factors affecting insurers’ decision to hedge with derivatives instruments and the relationship between insolvency risk and the use of derivatives during the 2001-2003 period. Using the cross-sectional and panel estimation techniques, the firm-specific determinants of hedging are found to change from one epoch to another. The overall results from the first model indicate that the decision to participate in derivatives activities would not necessarily consistent with the decision on the extent of usage. We provide evidence of statistically significant relationship between derivatives usage and various proxies for scale economies and currency exposure. Our analysis of the second model suggests that the hedging activities have no significant effect on default risk facing by the insurers with the exception of volume decision in the non-life insurance firms. The risk reduction effect found in the non-life sector is significant after controlling for a number of risk-related factors that are indirectly associated with the derivatives hedging decisions.
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