Determinants of corporate hedging policies: A case of foreign exchange and interest rate derivative usage

Derivatives are mostly used by corporations to hedge their foreign exchange or interest rate risk, especially in Asian countries due to their highly volatile political and economic situation. Current study aimed to determine the factors affecting firms hedging policies of both foreign currency and interest rate derivative instruments of 105 non-financial firms listed on Karachi Stock Exchange for the period of 2004-2008. Logit model was used to test whether the firmʹs decision to use hedging instruments can increase firm value? For a detailed analysis, firmʹs endogenous policies were regressed separately to identify the effect of firmʹs investment and financing policies on firmʹs hedging policies. The estimated results supported the financial distress hypothesis, tax convexity, underinvestment hypothesis and managerial risk aversion hypothesis. Though, inconsistent with the theory, interest coverage ratio demonstrated positive effect on firms hedging policies that may be attributed to the lag period effect.