The Impact of Derivative Use on Default Probability Among Nonfinancial Firms: Evidence From European Firms

ABSTRACT This paper examines how institutional environments shape the effectiveness of derivative hedging in reducing corporate default risk. Using hand‐collected data from non‐financial firms across nine European countries and various econometric methods to control for endogeneity, we provide novel evidence that the risk‐reducing benefits of derivative usage are significantly enhanced in stronger creditor rights settings. Additionally, we document that the default risk‐reducing effect of derivatives diminishes in countries with lower economic risk. We also find that for firms in severe financial distress, hedging does not reduce default likelihood. Regarding types of derivatives, we show that interest rate derivatives have a stronger default risk‐reducing effect than foreign exchange and commodity derivatives.