Effect of Derivative Usage on Firm Risk An Empirical Research on US Firms

After the 2008 Global Financial Crisis, risk management has played an increasingly important role in daily operations of many worldwide corporations. Financial derivatives that are often considered effective risk management instruments are broadly used by many companies. The objective of this paper is to examine the effect of derivative usage on total risk, systematic risk, idiosyncratic risk and cash flow volatility based on 494 non-financial US companies from 2012 to 2017. To answer the question, univariate and multivariate tests are conducted in my analysis. The results of the univariate analysis demonstrate that FX derivatives are the most popular derivatives in the US market and firms with higher foreign exposure, higher leverage, larger size, lower profitability, lower liquidity and lower growth are more likely to hedge. Results from multivariate analysis demonstrate that derivatives can reduce the total risk, systematic risk, idiosyncratic risk and cash flow volatility. Furthermore, consistent to the “Effective-match” theory proposed by Guay (1999), FX exposure could be effectively reduced by FX derivatives. Therefore, my results strongly support that firms use derivatives for hedging and there is no evidence for corporate speculation