Speculation

Speculation involves the buying, holding, and selling of stocks, commodities, futures contract, currencies, collectibles, real estate, or any valuable thing to profit from fluctuations in its price as opposed to buying it for use or for income ( via dividends, rent etc). Speculation or agiotage represents one of three market roles in western financial markets, distinct from hedging and arbitrage.

The economic role of speculation

The roles of speculators in a market economy are to absorb risk and to add liquidity to the marketplace by risking their own capital for the chance of monetary reward.

Related Topics:
Risk - Liquidity - Capital

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For example, if a certain market - say in pork bellies - had no speculators, only producers (pig farmers) and consumers (butchers etc) would participate in that market. With fewer players in the market, there would be a larger spread between the current bid and ask price of pork bellies. Any new entrant in the market who wants to either buy or sell pork bellies will be forced to accept an illiquid market and market prices that have a large bid-ask spread. A speculator (e.g. a pork dealer) will exploit the difference in the spread and, in competition with other speculators, reduce the spread thus creating a more efficient market.

Related Topics:
Spread - Efficient market

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Another example of the value of speculators is the ability of a pig farmer to sell his pork on a futures exchange at a known price ahead of its production.

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