DERIVATIVES FOR CAPITAL MARKET EFFICIENCY

Abstract

Derivative contracts transfer risk, especially price risk, to those who are able and willing to bear it. How they transfer risk is complicated and frequently misinterpreted. Derivatives have also been associated with some spectacular financial failures and with dubious financial reporting. This paper will discuss the role of derivative products in capital flows, especially in providing a means of both reducing and enhancing market risks associated with given net flows. It will emphasize how derivatives can be used to evade risk-control or prudential regulation, circumvent capital controls, drive the dynamics of currency instabilities, and obscure true risk positions and thereby undermine the usefulness of balance of payments capital account categories. Financial derivatives (credit default swaps, options, etc) are screwing over the economy because too much money is being poured into the invisible (derivatives) market. This probably undervalues the prices of the underlying goods/assets/etc in the real market (instead, investors should just simply buy the stocks, etc and the increased demand would drive up the stock price and it would make everyone happy). All these derivatives may contribute to risk… it may encourage people to take on unreasonable risk and could lead to drastic market volatility.