Hedging and the Value of Waiting to Investa

We analyze the optimal hedging policy of a firm that has flexibility in the timing of investment, but faces a constraint on its ability to raise external funds. By reducing the risk that the firm's ability to finance investment will disappear, hedging restores its timing flexibility and thus raises the payoff threshold required to justify investment. The principal implication of this result is that hedging adds value not only by allowing investment to occur, as is the case in Froot et al (1993), but also by allowing investment to be delayed in circumstances when it might otherwise have to occur prematurely. This observation may help explain the empirical findings that investment rates do not differ between hedgers and non-hedgers, and that hedging propensities do not depend on measures of growth opportunities.