Who bets against hedgers and how much they trade? A theory and empirical tests

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This article provides a simple equilibrium model of a futures market. Since the futures market is a zero sum game, some firms will, in equilibrium, end up being 'speculators' who bet against 'hedgers'. We show it is firms that have high initial capital and/or poor production opportunities that are the most likely candidates to bet against the hedgers. In equilibrium, these groups earn a premium in order to provide this insurance so that speculating increases value. We also provide some results that imply an inverted U shaped relationship between trading volume and the level of futures prices. Empirical evidence from the S&P futures contract provides strong empirical support for this theoretical result.

Document Type: Research Article

DOI: http://dx.doi.org/10.1080/00036840701493766

Affiliations: 1: College of Business Administration, University of Rhode Island, Kingston, RI 02881 2: Department of Economics and Finance, School of Business, Clayton State University, Morrow, GA 30260, USA 3: J. Mack Robinson College of Business, Georgia State University, Atlanta, GA 30303-3083

Publication date: December 1, 2009

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