Why the law hates speculators: Regulation and private ordering in the market for OTC derivatives

A wide variety of statutory and common law doctrines in American law eviden ce hostility towards speculation. Conventional economic theory, however, ge nerally views speculation as an efficient form of trading that shifts risk to those who can bear it most easily and improves the accuracy of market pr ices. This Article reconciles the apparent conflict between legal tradition and economic theory by explaining why some forms of speculative trading ma y be inefficient. It presents a heterogeneous expectations model of specula tive trading that offers important insights into antispeculation laws in ge neral, and the ongoing debate concerning over-the-counter (OTC) derivatives in particular. Although trading in OTC derivatives is presently largely unregulated, the C ommodity Futures Trading Commission recently announced its intention to con sider substantively regulating OTC derivatives under the Commodity Exchange Act (CEA). Because the CEA is at heart an antispeculation law, the hererog eneous expectations model of speculation offers policy support for the CFTC 's claim of regulatory jurisdiction. This model also, however, suggests alt ernative to the apparently binary choice now available to lawmakers (ie., e ither regulate OTC derivatives under the CEA, or exempt them). That alterna tive would be to regulate OTC derivatives in the same manner that the commo n law traditionally regulated speculative contracts: as permitted, but lega lly unenforceable, agreements. By requiring derivatives traders to rely on private ordering to ensure the performance of their agreements, this strate gy may offer significant advantages in discouraging welfare-reducing specul ation based on heterogeneous expectations while protecting more beneficial forms of derivatives trading.