Hedging, Speculation and Shareholder Value

We examine a common assumption in the risk management literature, that derivatives transactions have zero intrinsic net worth, and add value only because they help firms mitigate market imperfections by hedging financial risk. For a sample of 92 North American gold mining firms we infer the quarterly cash flows that each firm derives specifically from its derivatives transactions. We find that these derivatives cash flows are significantly positive on average, both economically and statistically. These positive derivatives cash flows appear to translate into increases in shareholder value, since we find no evidence of an upward adjustment of firms’ systematic risk to offset the cash flow gains. The bulk of the gains appear to be the result of forward prices generally exceeding realized future spot prices in the gold market. Consistent with anecdotal evidence on selective hedging, we find that hedge ratios and derivatives cash flows are too volatile to be explained purely by changes in firms’ hedging fundamentals. However, the gains from selective hedging are small at best. To our knowledge, this is the first study to show that corporate derivatives use can be intrinsically valuable. Our results highlight a potentially important motive for the corporate use of derivatives that the literature has hitherto ignored, and have implications for the measurement of hedging benefits