Published on: 11Dec2018 Speaker
 Dr Amrit Judge Associate Professor of Finance Director of MBA Programme Nottingham University Business School

Date  11 December 2018 (Tuesday) 
Venue  HSS Meeting Room 4 (HSS0471) 
Time  11:00am – 12:30pm

Abstract:
This paper examines the effects of corporate derivative use on the probability of financial distress. We do so by constructing a unique and very detailed handcollected dataset of UK nonfinancial firms’ derivative use during the period 19992000. Our results show that use of derivatives is associated with a reduction in the probability of default for our sample firms and that most of the reduction in the likelihood of default is generated in the first year of derivative use. We find that interest rate derivative use has a greater impact on the probability of default than foreign currency derivative use. Furthermore, hedging with derivatives has a significantly larger impact on near term default than longterm default probabilities, consistent with the notion that derivatives are better suited to manage short term rather than longterm financial price risks. Using several measures of aggregate credit risk conditions we show that the magnitude of the difference in default probabilities between derivatives users and nonusers widens during periods of heightened economywide credit risk and is dampened in periods of low economywide credit risk, suggesting that firms are managing default risk when it matters most. We also find evidence consistent with speculation. Our results show that the use of derivatives by large firms increase the probability of default relative to all derivative users and nonusers. Furthermore, we find that firms with higher prederivative default risk generate larger reductions in the likelihood of default from using derivatives, suggesting that those firms expected to benefit most from derivatives use are the ones doing so. In subsequent analysis, we find that the use of interest rate swaps in general can lead to the reduction of default probability. However, we find that large firms that swap into floating rate debt increase their default risk. Finally, we show that the use of derivatives lowers the cost of bank syndicated debt and in doing so increases firm value.
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