Corporate risk management: integrating liquidity, hedging, and operating policies

We analyze the value created by a dynamic integrated risk management strategy involving liquidity management, derivatives hedging, and operating flexibility, in the presence of several frictions. We show that liquidity serves a critical and distinct role in risk management, justifying high levels of cash. We find that the marginal value associated with derivatives hedging is likely to be low, though we explain why some empirical studies find a higher value. We explore the complex interactions between operating flexibility and financial risk management, finding that substitution effects are nonmonotonic and are affected by operating leverage, the nature of operating flexibility, and the effectiveness of the hedging instrument. Key words: finance; corporate finance; risk management; hedging; operating flexibility, cash management History: Received June 11, 2012; accepted March 19, 2013, by Jerome Detemple, finance. Published online in Articles in Advance September 3, 2013.
1. Introduction Risk management has become a critical dimension of corporate financial policy, particularly in light of recent global financial and economic crises. The corporate risk management literature focuses on [...]