Abstract

We analyze the demand for hedging and insurance by a firm facingcash-flow risks. We study how the firm’s liquidity managementpolicy interacts with two types of risk: a Brownian risk that canbe hedged through a financial derivative, and a Poisson risk thatcan be insured by an insurance contract. We find that the patternsof insurance and hedging decisions are pole apart: cash-poor firmsshould hedge but not insure, whereas the opposite is true for cashrichfirms. We also find non-monotonic effects of profitability. Thismay explain the mixed findings of empirical studies on corporatedemand for hedging and insurance.