Journal of Financial and Quantitative Analysis

Research Articles

The Two Sides of Derivatives Usage: Hedging and Speculating with Interest Rate Swaps

Sergey Chernenkoa1 and Michael Faulkendera2

a1 Fisher College of Business, Ohio State University, 818 Fisher Hall, Columbus, OH 43210.

a2 Smith School of Business, University of Maryland, 4411 Van Munching Hall, College Park, MD 20742.


Existing cross-sectional findings on nonfinancial firms’ use of derivatives that are usually interpreted as the result of hedging may alternatively be due to speculation. Panel data examinations can distinguish between derivatives practices that endure over time and are therefore more likely to result from hedging, and those that are more transient, thus more consistent with speculation. Our decomposition results indicate that hedging of interest rate risk is concentrated among high-investment firms, consistent with costly external finance. Simultaneously, firms appear to use interest rate swaps to manage earnings and to speculate when their executive compensation contracts are more performance sensitive.

(Online publication June 01 2011)


We thank Alessandro Beber, Dan Bergstresser, Mitchell Berlin, Hendrik Bessembinder (the editor), Greg Brown, Lynnea Brumbaugh-Walter, Charlie Calomiris, Mihir Desai, Doug Diamond, Mark Flannery, Kenneth French, Gerald Garvey, Todd Gormley, Dirk Hackbarth, Bill Marshall, Todd Milbourn, Bernadette Minton, Neil Pearson, Mitchell Petersen, Gordon Phillips, Josh Rauh, David Scharfstein, Antoinette Schoar, Chandra Seethamraju, Steven Sharpe, Jeremy Stein, Anjan Thakor, Peter Tufano, Ivo Welch, Rohan Williamson, an anonymous referee, and seminar participants at Columbia University, the Federal Deposit Insurance Corporation (FDIC), the Federal Reserve Bank of Philadelphia, Harvard University, Massachusetts Institute of Technology, the National Bureau of Economic Research (NBER) Summer Corporate Finance Workshop, University of Illinois at Urbana-Champaign, University of Kentucky, University of Maryland, University of North Carolina, University of Virginia, Washington University in St. Louis, and the 2006 Western Finance Association Annual Meeting for their helpful comments and suggestions. We thank Joe Kawamura and Qiwu Zhou for research assistance. This paper is primarily funded by a grant from the FDIC Center for Financial Research; we thank the Center for its gracious financial support.