Impact of SFAS 133 on Speculation and Hedging
28 Pages Posted: 19 Oct 2007
Date Written: September 13, 2007
The Statement of Financial Accounting Standards No.133 (SFAS 133) allows firms to apply hedge accounting only to qualified hedges that pass effectiveness tests, and requires that firms evaluate the effectiveness of hedges in every quarter. Unqualified hedges and the ineffective portion of the hedges are required to be marked to market, and the unrealized gains/losses are to be recognized in earnings immediately. It appears that FASB tries to use SFAS 133 to restrain speculation while continuing to encourage effective hedges. This paper, however, shows that the early recognition of unqualified hedges may instead be in favor of motivating speculation. Even in the case where the policy favors motivating hedges, the shareholders' wealth is likely to be worse off. In addition, sometimes the new recognition policy prevents the firms from using financial derivatives, even through the firms used to use financial derivatives for hedging purpose only.
Keywords: speculation, hedging, SFAS 133
JEL Classification: D82, J41, M41, M44
Suggested Citation: Suggested Citation