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  • The Two Sides of Derivatives Usage: Hedging and Speculating with Interest Rate Swaps

  • Sergey Chernenko, Michael Faulkender
  • Journal:
    Journal of Financial and Quantitative Analysis / Volume 46 / Issue 6 / December 2011
    Published online by Cambridge University Press:
    01 June 2011, pp. 1727-1754
    Print publication:
    December 2011
    • Article
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  • Existing cross-sectional findings on nonfinancial firms’ use of derivatives that are usually interpreted as the result of hedging may alternatively be due to speculation. Panel data examinations can distinguish between derivatives practices that endure over time and are therefore more likely to result from hedging, and those that are more transient, thus more consistent with speculation. Our decomposition results indicate that hedging of interest rate risk is concentrated among high-investment firms, consistent with costly external finance. Simultaneously, firms appear to use interest rate swaps to manage earnings and to speculate when their executive compensation contracts are more performance sensitive.