The effect of foreign currency hedging on the probability of financial distress |
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Authors: | Shane Magee |
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Affiliation: | Applied Finance Centre, Macquarie University, Sydney, NSW, Australia |
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Abstract: | This paper investigates the effect of foreign currency hedging with derivatives on the probability of financial distress. I use Merton’s (1974) structural default model to compute firms’ distance to default as a proxy for their probability of financial distress. Using an instrumental variables approach to control for endogenous hedging and leverage, I find that the extent of foreign currency hedging is associated with a lower probability of financial distress. Whereas previous research finds that the probability of financial distress is a determinant of a firm’s hedging policy, this paper provides direct evidence supporting the hypothesis that the extent of hedging reduces a firm’s probability of financial distress. |
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Keywords: | Corporate hedging Derivatives Financial distress Distance to default F30 G32 G33 |
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