The effect of foreign currency hedging on the probability of financial distress

Shane Magee*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

10 Citations (Scopus)

Abstract

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.

Original languageEnglish
Pages (from-to)1107-1127
Number of pages21
JournalAccounting and Finance
Volume53
Issue number4
DOIs
Publication statusPublished - Dec 2013

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