Corporations are responsible for a significant fraction of hedging volume on futures and options markets, but there is as yet no satisfactory rigorous theory that explains why financial hedging by corporations takes place. The contribution from this project comes from developing a theory of corporate financial hedging based on agency costs. This theory will provide insights into the interrelations between information, managerial compensation schemes, the selection of investment projects, and corporate financial hedging. The project also addresses the foundations of financial economic theory. Asset pricing theory depends on a restrictive model of intertemporal preferences for the analysis of financial dynamics. Specifically, individual intertemporal preferences are assumed to be additively separable. The investigator pioneered in his previous work the use of Stochastic Differential Utility (SDU) as a model of preferences for consumption processes in a continuous- time setting. This project provides further elaboration of the SDU preference model, the establishment of conditions for the existence of market equilibrium in settings with heterogeneous agents, and applications to asset pricing theory.
