Price Shocks and Financial Hedging: Empirical Analysis
In this dissertation, I study the relationship between financial hedging and financial constraints. The existing literature has defined financial constraints endogenously based on such firm characteristics as size, and the research has shown that unconstrained firms hedge more often than constrained firms. These results contradict those theories of financial hedging proposing that constrained firms should hedge more than unconstrained firms. In this paper, I treat the sudden drop in the price of oil in the fourth quarter of 2014 as an exogenous shock that constrained oil producers. By studying a sample of 113 U.S. oil and gas producers in the period between 2010 and 2016, I show that these firms increased their hedging activities following drops in the price of oil. Further, constrained firms increased their hedging activities more than unconstrained firms. These results indicate a positive relationship between financial hedging and financial constraints. To the best of my knowledge, this paper provides the first empirical evidence in support of theories of financial hedging. The empirical results, yielded from a dynamic structural model, shows that the optimum level of financial hedging is negatively related to prices. Since the expected probability of distress is higher when prices are lower, the dynamic model reconfirms the empirical finding of this paper, which is that firms hedge more when they become more constrained. To resolve the high dimensional model, I use the stochastic simulation technique, which provides a novel approach to corporate finance literature.