Risk Management and Firm Value: Evidence from Weather Derivatives

TLDR

The study uses the introduction of weather derivatives as an exogenous shock to firms’ ability to hedge weather risks, employing a natural experiment with energy firm data to show that derivatives increase valuations, investments, and leverage. Active risk management via weather derivatives raises firm value, especially for weather‑sensitive firms, by boosting valuations, investments, and leverage, demonstrating real consequences for firm outcomes.

Abstract

ABSTRACT This paper shows that active risk management policies lead to an increase in firm value. To identify the effect of hedging and to overcome endogeneity concerns, we exploit the introduction of weather derivatives as an exogenous shock to firms’ ability to hedge weather risks. This innovation disproportionately benefits weather‐sensitive firms, irrespective of their future investment opportunities. Using this natural experiment and data from energy firms, we find that derivatives lead to higher valuations, investments, and leverage. Overall, our results demonstrate that risk management has real consequences on firm outcomes.