None other than Warren Buffet has attacked derivatives as “time bombs – both for the parties that deal in them and the economic system.”
But now, for the first time, researchers have found that hedging can increase firm value. In a pioneering study published in the Journal of Finance, Michigan State University’s Hayong Yun and Stanford University’s Francisco Pérez-Gonzálezshow that electric and gas utilities that used derivatives to hedge against unpredictable weather experienced a “positive and significant effect” on the value of their firms.
“Many people have a perception that derivatives are evil, that they helped destroy the economy,” said Yun, MSU assistant professor of finance.
“And while there is some truth to the argument that derivatives were overused, our research provides the first fundamental evidence that hedging with derivatives can improve company value.” Derivatives are widely used in the corporate world – from a CEO’s stock options to corn futures, in which a cereal maker, for example, purchases 2,500 corn bushels from a farmer at current prices for delivery in three months. Mortgage-backed securities, another type of derivative, were blamed for creating the housing bubble and subsequent recession.
Yun said he’s not advocating that derivatives be completely deregulated. But at the same time, his research suggests derivatives – when used wisely – have an upside and should not be discounted as a potential instrument for company growth. In the study, the researchers examined the value of publicly traded electric and gas utilities in the United States both before and after a weather derivatives market opened in the late 1990s.
The market allowed the utilities to sell weather futures to investors. Before the market opened, utility companies that were susceptible to unpredictable weather – such as those in the Midwest – were valued 3 percent to 4 percent lower, on average, than utilities where the weather was more stable, such as in southern California and Texas. After the weather derivative market opened, that difference disappeared. Investors no longer cared the utility was located in an unstable-weather locale.
In essence, the use of derivatives leveled the playing field, and utilities in the Midwest and other areas with unstable weather had equal value to those in stable-weather areas, as well as increased leverage and investments. The study was recently awarded the 2013 Brattle Group First Prize in Corporate Finance, given annually to the best corporate finance paper published in the highly selective Journal of Finance.
Andy Henion | EurekAlert!
Innovation among SMEs continues to fade
25.02.2015 | KfW
RWI/ISL Container Throughput Index: Growth of world trade continues to slow down
19.02.2015 | Rheinisch-Westfälisches Institut für Wirtschaftsforschung e.V.
In an experiment at the Department of Energy's SLAC National Accelerator Laboratory, scientists precisely measured the temperature and structure of aluminum as...
The IPH presents a solution at HANNOVER MESSE 2015 to make ship traffic more reliable while decreasing the maintenance costs at the same time. In cooperation with project partners, the research institute from Hannover, Germany, has developed a sensor system which continuously monitors the condition of the marine gearbox, thus preventing breakdowns. Special feature: the monitoring system works wirelessly and energy-autonomously. The required electrical power is generated where it is needed – directly at the sensor.
As well as cars need to be certified regularly (in Germany by the TÜV – Technical Inspection Association), ships need to be inspected – if the powertrain stops...
When an earthquake hits, the faster first responders can get to an impacted area, the more likely infrastructure--and lives--can be saved.
The Atlantic overturning is one of Earth’s most important heat transport systems, pumping warm water northwards and cold water southwards. Also known as the Gulf Stream system, it is responsible for the mild climate in northwestern Europe.
Scientists now found evidence for a slowdown of the overturning – multiple lines of observation suggest that in recent decades, the current system has been...
Because they are regularly subjected to heavy vehicle traffic, emissions, moisture and salt, above- and underground parking garages, as well as bridges, frequently experience large areas of corrosion. Most inspection systems to date have only been capable of inspecting smaller surface areas.
From April 13 to April 17 at the Hannover Messe (hall 2, exhibit booth C16), engineers from the Fraunhofer Institute for Nondestructive Testing IZFP will be...
25.03.2015 | Event News
19.03.2015 | Event News
17.03.2015 | Event News
31.03.2015 | Life Sciences
31.03.2015 | Materials Sciences
31.03.2015 | Earth Sciences