SFB 303 Discussion Paper No. A - 222
Author: DeMarzo, Peter, and Darrell Duffie
Title: Corporate Financial Hedging with Proprietary Information
Abstract: This paper is based on the idea that the elimination of noise in a firm's dividend stream is unanimously
supported by shareholders. In order to make succinct statements, however, we basically rely on the strong
assumption that dividends include noise (with respect to the information available to shareholders) that is
spanned by financial markets, given the information known to the firm. Our conclusions are thus related to the
intuition of the spanning literature on unanimity of production decisions, beginning with Diamond (1967) and
Ekern and Wilson (1974). The remainder of the paper proceeds as follows: Section 2 outlines the primitive
notions in the model in a simple two-period setting under uncertainty. In order to provide some contrasting
background to our results, Section 3 reviews the standard MM theory in our setting. Section 4 presents the basic
idea we have to offer in the bluntest possible terms; hopefully the reader will find the assumptions in the later
sections more palatable. Section 5 presents our notion of unanimously supported corporate financial hedging
strategies. In Section 6, which could be viewed as the principle body of our results, we present unanimously
supported hedging strategies in various settings. Finally, Section 7 shows that when firms adopt such financial
hedging policies, the resulting equilibrium allocations are in fact constrained Pareto optimal.
Keywords:
JEL-Classification-Number:
Creation-Date: January 1989
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