Hedging the Value of Waiting∗

We analyze the optimal hedging policy of a firm that has flexibility in the timing of in-vestment. Conventional wisdom suggests that hedging adds value by alleviating the under-investment problem associated with capital market frictions. However, our model shows that hedging also adds value by allowing investment to be delayed in circumstances where the same frictions would cause it to commence prematurely. Thus, hedging can have the para-doxical effect of reducing investment. We also show that greater timing flexibility increases the optimal quantity of hedging, but has a non-monotonic effect on the additional value created by hedging. These results may help explain the empirical findings that investment rates do not differ between hedgers and non-hedgers, and that hedging propensities do not depend on standard measures of growth opportunities. JEL classification: G31, G3