The Informational Role of Corporate Hedging

Abstract

We study the informational role of corporate hedging, comparing two hypotheses. Under the “opacity” hypothesis, corporate hedging makes earnings less informative, renders the firm opaque, and increases informed traders’ profitability. Under the “transparency” hypothesis, hedging reduces uncertainty and erodes the informed traders’ information advantage and profitability. Our tests support the transparency hypothesis. Hedging is associated with lower uncertainty (lower implied volatility and analyst forecast dispersion, and greater breadth of ownership). It is also associated with a lower informed trading intensity, in particular for short selling. Short selling profits are more than twice lower on the stocks of firms engaging in corporate hedging. The online appendix is available at https://doi.org/10.1287/mnsc.2016.2717 . This paper was accepted by Neng Wang, finance.