Abstract

http://ssrn.com/abstract=1161278
 
 

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Do Derivatives Disclosures Impede Sound Risk Management?


Haresh Sapra


University of Chicago - Booth School of Business

Hyun Song Shin


Princeton University - Department of Economics

July 16, 2008

Chicago GSB Research Paper No. 08-04

Abstract:     
We model an environment in which firms disclose only one side of a hedging transaction, namely the gain or loss on the forward. However, the firm cannot credibly disclose the other side of the hedging transaction, namely the underlying exposure that is being hedged. We show that because the firm cannot credibly communicate that the exposure from its underlying project is hedgeable, greater transparency in the firm's derivative activities distorts firms' hedging decisions.

The nature of these distortions depend crucially on (i) firms' information quality about their project types and (ii) the market's prior beliefs about whether or not firms have hedgeable projects.

For most reasonable levels of information quality, we find that instead of impeding risk management, derivative disclosures are likely to induce firms to engage in excessive speculation.

Number of Pages in PDF File: 35

JEL Classification: M41, M44, M45, G13

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Date posted: July 17, 2008  

Suggested Citation

Sapra, Haresh and Shin, Hyun Song, Do Derivatives Disclosures Impede Sound Risk Management? (July 16, 2008). Chicago GSB Research Paper No. 08-04. Available at SSRN: http://ssrn.com/abstract=1161278 or http://dx.doi.org/10.2139/ssrn.1161278

Contact Information

Haresh Sapra (Contact Author)
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
Hyun Song Shin
Princeton University - Department of Economics ( email )
Princeton, NJ 08544-1021
United States

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