When hedging fails: what every CEO should know about speculation

Purpose – The purpose of this paper is to explain the theory of speculation to corporate executives. It is important that corporate hedgers understand how bubbles develop to effectively adjust their corporate hedging strategies. Since excess speculation is always the primary cause of all bubbles, it is mandatory that corporate executives understand the basics of speculation theory. Design/methodology/approach – The paper uses the case of Southwest Airlines to illustrate how corporate hedging programs can fail in an environment of asset price bubbles. Further, it reviews key academic theoretical articles on speculation, with emphasis on applied concepts. Findings – Corporate hedgers must recognize inflating bubbles and acknowledge the positive feedback trading. Corporate hedgers must refrain from becoming the positive feedback traders themselves. Corporate hedgers can hedge the speculative bubbles by having insurance in form of options against potential bubbles at all times. Originality/value – The paper can be a valuable reference source for corporate managers with diverse educational and business backgrounds because it widely disseminates the theory that only the closed circle of the trading community and narrowly specialized researches practice and fully understand.