Do Mandatory Hedge Disclosures Discourage or Encourage Excessive Speculation?

38 Pages Posted: 30 Jul 2008

See all articles by Haresh Sapra

Haresh Sapra

Booth School of Business, University of Chicago

Date Written: August 16, 2007

Abstract

In order to shed some light on the desirability of hedge disclosures, I investigate the consequences of hedge disclosures on a firm's risk management strategy. Several major results emerge from this analysis. First, greater transparency about a firm's derivative activities is not necessarily a panacea for imprudent risk management strategies. I show that such transparency actually induces the firm to take excessive speculative positions in the derivative market. Second, I show that the firm may choose a prudent risk management strategy in the absence of hedge disclosures. However, the selection of a prudent risk management comes at a cost. The firm's production policy is distorted in the absence of hedge disclosures.

These findings suggest that the FASB must carefully investigate the trade-offs between production distortions and risk management distortions in evaluating the desirability of mandatory hedge disclosures for all firms.

JEL Classification: M40, M41, M44, M45, M46, L23

Suggested Citation

Sapra, Haresh, Do Mandatory Hedge Disclosures Discourage or Encourage Excessive Speculation? (August 16, 2007). Available at SSRN: https://ssrn.com/abstract=1186248 or http://dx.doi.org/10.2139/ssrn.1186248

Haresh Sapra (Contact Author)

Booth School of Business, University of Chicago ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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