I thank Don Adams, Phil Dolan, Robert Faff (the Editor), Doug Foster, Elizabeth Sheedy, Tom Smith, Garry Twite, an anonymous referee, and seminar participants at the Australian National University, Macquarie University and the 2008 Accounting and Finance Association of Australia and New Zealand Conference for their helpful comments and suggestions. Financial support from the Macquarie University Applied Finance Centre is gratefully acknowledged. All remaining errors are mine.
The effect of foreign currency hedging on the probability of financial distress
Article first published online: 13 JUN 2012
© 2012 The Author. Accounting and Finance © 2012 AFAANZ
Accounting & Finance
Volume 53, Issue 4, pages 1107–1127, December 2013
How to Cite
Magee, S. (2013), The effect of foreign currency hedging on the probability of financial distress. Accounting & Finance, 53: 1107–1127. doi: 10.1111/j.1467-629X.2012.00489.x
- Issue published online: 26 NOV 2013
- Article first published online: 13 JUN 2012
- Received 2 June 2011; accepted 25 April 2012 by Robert Faff (Editor).
- Corporate hedging;
- Financial distress;
- Distance to default
This paper investigates the effect of foreign currency hedging with derivatives on the probability of financial distress. I use Merton’s (1974) structural default model to compute firms’ distance to default as a proxy for their probability of financial distress. Using an instrumental variables approach to control for endogenous hedging and leverage, I find that the extent of foreign currency hedging is associated with a lower probability of financial distress. Whereas previous research finds that the probability of financial distress is a determinant of a firm’s hedging policy, this paper provides direct evidence supporting the hypothesis that the extent of hedging reduces a firm’s probability of financial distress.