Dr Jekyll and Mr Hyde: Feedback and Welfare When Hedgers Can Acquire Information

Jacques Olivier

♦ I ask whether hedgers who speculate should be regulated differently from other speculators in a model where information acquisition is endogenous and information has real effects. Hedging benefits and feedback effect generate strategic complementarities between market-maker, firm manager, and trader, which causes multiple equilibria. Gains from trade are lower when hedgers acquire information while speculators may produce less information than socially desirable. A “Volcker rule” separating hedging and speculative activities may help select the higher welfare equilibrium. When too little information is produced, contracts whereby a firm subsidizes losses of designated market-makers to make prices more informative increase welfare.

Read it here.