Hedge disclosures, future prices, and production distortions

In this paper, we identify social benefits to hedge accounting disclosures that have not previously been examined. We show that from the perspective o f price efficiency in the futures market the key information that is provid ed by hedge accounting is information about firms' underlying risk exposure s. Without this information, the futures price confounds information regard ing firms' hedge-motivated trades with their speculative trades, making the futures price inefficient. Our model shows that an inefficient futures pri ce causes significant externalities by distorting the production choices of an entire industry. In the presence of hedge disclosures, the futures pric e appropriately informs production decisions in the whole industry. In addi tion to distortion in production choices, we also investigate the effect of an inefficient futures price on the risk-sharing role of the futures marke t. We find that lack of appropriate information about hedge disclosures als o distorts the risk-sharing role of the futures market, thereby resulting i n an increase in risk premium embedded in the futures price. Using numerica l calculations, we demonstrate that the magnitude of the distortions in exp ected industry output can be substantial.