Derivative security markets have shown
extraordinary growth over the past 10 years.
But certain events have raised concern about
the risks associated with derivatives trading.
The stock market crash of October 1987 has, in
part, been blamed on portfolio insurance strategies
that used futures markets. Large losses
associated with the use of derivatives by firms
such as Procter & Gamble ($137 million),
Metallgesellschaft ($1 billion), and Barings PLC
($1.3 billion), and by Orange County, California
($1.7 billion) have led to fear among some
market participants that derivatives trading is
a very risky activity that could lead to a widespread
disruption of the financial system.
What sometimes gets lost in the popular discussion
about derivative-related losses are the
benefits that derivative securities provide to
firms, investors, and the economy as a whole.
Derivative securities such as options, forwards
and futures, and swaps can provide firms and
investors with opportunities that might not otherwise
be available. Derivatives aid in the allocation
of risk across investors and firms, and
they can lower the costs of diversifying portfolios.
Derivative prices reveal information to
investors that can make financial markets more
stable.