Corporate Hedging and the Variance of Stock Returns

We investigate the effect of hedging commodity price risk on the idiosyncratic variance of stock returns. We introduce a variant of the standard Difference-in-Differences methodology to assess the impact of an intervention on the average idiosyncratic variance of stock returns. Our results show that following the introduction of new commodity derivatives in the Chicago Mercantile Exchange, treated firms experience up to a 40% drop in the variance of stock returns. The effect is persistent over time and is associated with an increase in profit margins, investment and access to credit lines, and a drop in cash holdings. Our results establish a direct link between corporate risk management policies and stock return behavior.