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Incentive mechanisms and hedging effectiveness – an experimental study

Lu Zhang (Management School, Xi’an Jiaotong University, Xi’an, China)
Difang Wan (Management School, Xi’an Jiaotong University, Xi’an, China)
Wenhu Wang (School of Management, Xi’an Jiaotong University, Xi’an, China)
Chen Shang (Xi’an Audit Center, Audit Office of Central Military Commission, Xi’an, China)
Fang Wan (Derivatives Business, Shenzhen Stock Exchange, Shenzhen, China)

China Finance Review International

ISSN: 2044-1398

Article publication date: 30 July 2018

Issue publication date: 30 July 2018

304

Abstract

Purpose

The purpose of this paper is to analyze the role of four different incentives in improving hedging effectiveness and propose an alternative regulatory mechanism for China’s futures market.

Design/methodology/approach

The research method that this study uses is a laboratory experiment, and this study follows the basic norms of experimental research. In addition, this paper designs and conducts a game experiment between hedgers and futures brokerage firms (FBFs) under different incentive mechanisms.

Findings

By analyzing the experimental data, it is found that compared with other incentive mechanisms, hedgers’ willingness to hedge and FBFs’ regulatory intention are both significantly higher for the dynamic linkage updating mechanism, indicating that hedgers have a stronger willingness to follow their hedging plan, and FBFs are more responsible for their regulatory behaviors. Additionally, the dynamic linkage updating mechanism has a long-term impact on effective hedging in the futures market.

Research limitations/implications

The findings suggest that the dynamic linkage updating mechanism is beneficial for effectively restricting both hedgers’ over-speculation and FBFs’ regulatory slack and improving the hedging efficiency of the futures market.

Practical implications

To solve the problem of inefficient hedging in China’s futures market, i.e., hedgers’ over-speculation and FBFs’ passive collusion with hedgers, the regulators of China’s futures market should reform the existing incentives and adopt a dynamic linkage updating mechanism to encourage all the participants to actively improve hedging effectiveness.

Originality/value

This paper analyzes and verifies, for the first time, the role of the dynamic linkage updating mechanism in the investing behaviors of hedgers and the regulatory behaviors of future brokerage firms. The futures market experiment that was designed and used in this study is a pioneering and exploratory experiment that applies game theory and mechanism design theory to the field of behavioral finance.

Keywords

Acknowledgements

The authors would like to thank three anonymous reviewers for their helpful comments and suggestions and acknowledge financial support from the Chinese National Science Funds (Grant No.71373202 and 71671138), Experiment Center for the Teaching of Management Education, Xi’an Jiaotong University (Demo-Center at State Level for Experiment Teaching) and The Key Lab of the Ministry of Education for Process Control and Efficiency Engineering.

Citation

Zhang, L., Wan, D., Wang, W., Shang, C. and Wan, F. (2018), "Incentive mechanisms and hedging effectiveness – an experimental study", China Finance Review International, Vol. 8 No. 3, pp. 332-352. https://doi.org/10.1108/CFRI-06-2017-0077

Publisher

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Emerald Publishing Limited

Copyright © 2018, Emerald Publishing Limited

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