Forward Markets, Stock Markets, and the Theory of the Firm



    Search for more papers by this author
    • Graduate School of Business, University of Texas. This research was partially supported by a grant from the Graduate School of Business, University of Texas. I would like to thank Stephen Smith and George Morgan for commenting on earlier drafts of this paper. I would also like to thank the referees for comments that significantly improved this paper.


This paper models a competitive financial market economy in which there are forward markets as well as stock and bond markets. Although there are separation theorems in the stock and forward markets literatures, this analysis shows that neither separation theorem survives in this integrated financial market economy. Next, the analysis shows that the separation results hold and are equivalent if the manager has an appropriate compensation package. Then the model is modified to allow for depreciation charges and tax credits. A positive theory of hedging is developed that shows that the corporation can preserve deductions and credits by hedging and so increase corporate value.