Life Insurance or Lottery: Are Corporations Managing or Taking Risks with Derivatives?

The nature of corporate hedging behavior is largely unexplored in the existing empirical literature. We attempt to fill this gap by analyzing data from annual financial statements of 425 large US corporations. The sample reveals that many firms actively manage their exposures with sizable derivative positions. Non-financial firms are active in both currency and interest rate derivatives. Contrary to current reports of large derivative losses at a few corporations, such losses are atypical. Compared to corporations that do not use financial derivatives, corporations that do use derivatives display few if any measurable differences in their risk characteristics that can be attributed to derivatives. These results are consistent with the notion that firms use financial derivatives to hedge their inherent exposures to underlying price risks rather than as a tool for speculation.