Cash Flow Hedging and Liquidity Choices

This paper studies the interaction between corporate hedging and liquidity policies. To motivate our empirical investigation, we present a theoretical model that shows how corporate hedging facilitates greater reliance on cost-effective, externally-provided liquidity in lieu of internal resources. We then test the predictions of the model by employing a new empirical approach that separates cash flow hedging from non-cash flow hedging. Using detailed, hand-collected data, we construct hedging instruments to address endogeneity, and find that cash flow hedging reduces the firm’s precautionary demand for cash and allows it to rely more on bank lines of credit. Furthermore, we find a significant positive effect of cash flow hedging on firm value. Overall, our results identify a new mechanism through which hedging affects corporate financial policies and firm value