In a recent comment, I considered the role of speculators in the current volatility of oil prices (and, with the help of a savvy columnist, found them innocent of price manipulation). At the time, I was under the impression that a speculator was the same kind of critter as a hedger or an arbitrageur. Not so. I have been corrected, and now realize these three creatures of the financial world are distinct individuals. What lumps them together is risk and risk assessment.
While a speculator is someone who accepts a risk of loss in return for a possible reward, the hedger is a more conservative creature. He or she–or, in the case of a business, it–makes an investment as insurance against loss. A hedger calculates the value-at-risk in an investment in one market and then makes a corresponding, opposite investment in a different market. The hedger swaps the probability of big win for the increased probability of a smaller win.
I, however, am a true fiscal chicken and 99 percent risk averse. So I believe that if risk is what the speculator and the hedger have in common, what they should also have in common is some good operational risk software. The same is true of the arbitrageur, whose modus operandi I will consider in my next column.