derivatives usage
Research Proposal
Impact of Financial Derivatives Usage on Corporate Market Value: Evidence from Non-Financial Firms in China
1. Introduction
Use of financial derivatives for hedging corporate risks purpose is becoming popular during the last two decades. International Swaps and Derivatives Association (ISDA) reports the notional amount outstanding of over the counter (OTC) derivatives increased by 25.6% from $511.1 trillion to $642.1 trillion over the five-year period ending December 31, 2012. This popularity is directly attributed to the volatility of the financial and capital market worldwide and to the crucial effect this volatility has on the performance and the profitability of firms. The unstable world financial environment and the activation of firms in the global market have created the imperativeness that firms use financial derivatives to hedge financial risk.
Many researchers have analyzed the determinants of hedging policy and its correlation with firms’ leverages, investment and growth opportunities and very little work has been done to check the impact of derivatives usage on firms’ value and the empirical evidence on the effects of derivative use on firms’ value is still mixed. Modigliani and Miller (1958) propose that in a perfect capital market where investors can equally access to these markets, the firms would not engage in hedging activities since they add no value. If the perfect capital markets assumption is not net, there may be rational reasons for the firm to hedge. Allayannis and Weston (2001) suggest that hedging foreign currency risk is associated with approximately 4% increases in market value. And Graham and Rogers (2002) find that hedging increases firms’ total market value by allowing firms to increase their debt capacity. By contrast, Guay and Kothari (2003) describe that the cash flows generated by hedging is modest and unlikely to change firms’ market value.
Most of the studies on derivatives usage have been done on the
Impact of Financial Derivatives Usage on Corporate Market Value: Evidence from Non-Financial Firms in China
1. Introduction
Use of financial derivatives for hedging corporate risks purpose is becoming popular during the last two decades. International Swaps and Derivatives Association (ISDA) reports the notional amount outstanding of over the counter (OTC) derivatives increased by 25.6% from $511.1 trillion to $642.1 trillion over the five-year period ending December 31, 2012. This popularity is directly attributed to the volatility of the financial and capital market worldwide and to the crucial effect this volatility has on the performance and the profitability of firms. The unstable world financial environment and the activation of firms in the global market have created the imperativeness that firms use financial derivatives to hedge financial risk.
Many researchers have analyzed the determinants of hedging policy and its correlation with firms’ leverages, investment and growth opportunities and very little work has been done to check the impact of derivatives usage on firms’ value and the empirical evidence on the effects of derivative use on firms’ value is still mixed. Modigliani and Miller (1958) propose that in a perfect capital market where investors can equally access to these markets, the firms would not engage in hedging activities since they add no value. If the perfect capital markets assumption is not net, there may be rational reasons for the firm to hedge. Allayannis and Weston (2001) suggest that hedging foreign currency risk is associated with approximately 4% increases in market value. And Graham and Rogers (2002) find that hedging increases firms’ total market value by allowing firms to increase their debt capacity. By contrast, Guay and Kothari (2003) describe that the cash flows generated by hedging is modest and unlikely to change firms’ market value.
Most of the studies on derivatives usage have been done on the