Derivatives and corporate risk management: Participation and volume decisions in the insurance industry

In this article, the authors analyze the derivatives holdings of U.S. insurers to empirically investigate the general hypotheses developed in the financial literature to explain why widely held, value-maximizing firms engage in risk management. The authors also develop a new hypothesis suggesting that although measures of risk and illiquidity will be positively associated with an insurer's decision to engage in risk management, these same measures of risk will be negatively related to the volume of hedging for the set of firms who choose to hedge using derivatives. The authors' analysis provides considerable support for general hypotheses about hedging by value-maximizing firms. The authors also find support for the hypothesis that, conditional on having risk exposures large enough to warrant participation, firms with a larger appetite for risk will engage in less hedging than firms with lower risk tolerance.