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Hedge Disclosures, Futures Prices, and Production Distortions

45 Pages Posted: 30 Jul 2008  

Chandra Kanodia

University of Minnesota - Carlson School of Management

Arijit Mukherji

Deceased

Haresh Sapra

University of Chicago - Booth School of Business

Raghu Venugopalan

University of Illinois at Urbana-Champaign

Date Written: December 7, 2000

Abstract

In this paper, we identify social benefits to hedge accounting disclosures that have not previously been examined. We show that from the perspective of price efficiency in the futures market the key information that is provided by hedge accounting is information about firms' underlying risk exposures. Without this information, the futures price confounds information regarding firms' hedge-motivated trades with their speculative trades, making the futures price inefficient. Our model shows that an inefficient futures price causes significant externalities by distorting the production choices of an entire industry. In the presence of hedge disclosures, the futures price appropriately informs production decisions in the whole industry. In addition to distortion in production choices, we also investigate the effect of an inefficient futures price on the risk-sharing role of the futures market. We find that lack of appropriate information about hedge disclosures also distorts the risk-sharing role of the futures market, thereby resulting in an increase in risk premium embedded in the futures price. Using numerical calculations, we demonstrate that the magnitude of the distortions in expected industry output can be substantial.

Keywords: hedge disclosures; future prices; information efficiency; production distortions

Suggested Citation

Kanodia, Chandra and Mukherji, Arijit and Sapra, Haresh and Venugopalan, Raghu, Hedge Disclosures, Futures Prices, and Production Distortions (December 7, 2000). Available at SSRN: https://ssrn.com/abstract=1186302 or http://dx.doi.org/10.2139/ssrn.1186302

Chandra Kanodia

University of Minnesota - Carlson School of Management ( email )

321 19th Avenue South
674 Management and Economics
Minneapolis, MN 55455
United States
612-624-6880 (Phone)
612-626-7795 (Fax)

Arijit Mukherji

Deceased

N/A

Haresh Sapra (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

Raghu Venugopalan

University of Illinois at Urbana-Champaign ( email )

601 E John St
Champaign, IL 61820
United States

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