Derivatives Supply and Corporate Hedging: Evidence from the Safe Harbor Reform of 2005

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Author Information : Erasmo Giambona (Syracuse University, Whitman School of Management)
Ye Wang (University of International Business and Economics)

Year of Publication : Review of Financial Studies (2020)

Summary of Findings : Capital markets frictions affect corporate risk management.

Research Questions : Do supply side fluctuations affect corporate hedging?

What we know : Our findings can help inform the current policy debate on derivatives’ margin requirements. Uncollateralized derivatives are considered to have played an important role in the global financial crisis. The sale of uncollateralized credit default swaps, for example, is considered to have contributed to the collapse of AIG in 2008. In response, the Dodd–Frank Act of 2010 required the U.S. prudential regulators to adopt rules requiring derivatives markets participants to collect margins. While this might improve the stability of financial markets, our findings suggest that, by limiting the supply of hedging instruments, more stringent margin requirements can affect corporate hedging and firm performance. Ultimately, our article can help inform the current policy debate by highlighting the need to balance market stability with the consequences that more stringent margin requirements might have for corporate risk management and firm performance.

Novel Findings : The study is the first to document that supply side frictions have a first order effect on corporate risk management.

Full Citations : Giambona, Erasmo and Wang, Ye, Derivatives Supply and Corporate Hedging: Evidence from the Safe Harbor Reform of 2005 (September 9, 2019). Available at SSRN: https://ssrn.com/abstract=3062048 or http://dx.doi.org/10.2139/ssrn.3062048

Abstract : This article analyzes the importance of supply-side fluctuations for corporate hedging. To establish a causal link, we exploit a regulatory change that allows derivatives counterparties to circumvent the Bankruptcy Code’s automatic stay: the Safe Harbor Reform of 2005. Following the reform-induced expansion in the availability of derivatives, fuel hedging by airlines nearing financial distress (those that benefited most from the reform) increased significantly in comparison with financially sound airlines. Similarly, we find that the hedging propensity increased in a general sample of non-financial firms. In line with theory, we also find that operating performance increased for the affected firms.

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The study is the first to document that supply side frictions have a first order effect on corporate risk management.

Erasmo Giambona
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