4.1.Stulz

Firms may not necessarily have to hedge add'l risk from trying to beat the mkt as it will naturally be diversifiable by the SH

• Reduce bankruptcy costs
• Reduce payments to stakeholders
• Reduce taxes

Eliminate costly lower tail outcomes, thereby minimizing the likelihood of financial distress and preserving the financial ability to carry out their investment objectives

• Larger firms hedge more than small firms
• Firms often engage in selective hedging (allow their views of mkt to influence hedging decision)
• Firms hedge on a transactional basis
• Shy away from giving up gains to avoid losses

• Highly rated firm w/ low debt to equity ratio: instead of not hedging could incr debt equity ratio to take adv of debt (taxes, etc.)
• Firm w/ low credit rating and significant prob of financial distress: engage in active risk management
• Firm in distress: should not hedge because most gains will go to debtholders anyway. Take higher risk to seek for higher return, because if loss, borne by debtholders

• Need massive historical data, so the larger the horizon the less data available
• Assumes a normal dist but long term have fatter tail

• Allows to measure risk over longer time horizon
• Studies path of firm, not just end result
• Allows for non-normal dist

• Gains from risky activities must be measured on a risk-adjusted basis
• Compensation systems should be desgined so that managers are compensated only for earning xs risk-adjusted returns, not just for taking risk