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Should We Fear Derivatives?

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  • Stulz, Rene M.

    (Ohio State U)

Abstract

This paper discusses the extent to which derivatives pose threats to firms and to the economy. After reviewing the derivatives markets and putting in perspective the various measures of the size of these markets, the paper shows who uses derivatives and why. The difficulties firms face in valuing derivatives portfolios are evaluated. Although academics pay much attention to no-arbitrage pricing results, the paper points out that there can be considerable subjectivity in the pricing of derivatives that do not have highly liquid markets. It is shown that the known risks of derivatives portfolios can generally be measured and managed well at the firm level. However, derivatives can create systemic risks when a market participant becomes excessively large relative to particular derivatives markets. Overall, the benefits of derivatives outweigh the potential threats.

Suggested Citation

  • Stulz, Rene M., 2004. "Should We Fear Derivatives?," Working Paper Series 2004-5, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    • Handle: RePEc:ecl:ohidic:2004-5
    as

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    File URL: http://www.cob.ohio-state.edu/fin/dice/papers/2004/2004-5.pdf
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    References listed on IDEAS

    as
    1. Bollen, Nicolas P. B., 1998. "A note on the impact of options on stock return volatility1," Journal of Banking & Finance, Elsevier, vol. 22(9), pages 1181-1191, September.
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    3. Rogers, Daniel A., 2002. "Does executive portfolio structure affect risk management? CEO risk-taking incentives and corporate derivatives usage," Journal of Banking & Finance, Elsevier, vol. 26(2-3), pages 271-295, March.
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    5. John R. Graham & Daniel A. Rogers, 2002. "Do Firms Hedge in Response to Tax Incentives?," Journal of Finance, American Finance Association, vol. 57(2), pages 815-839, April.
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    7. Guay, Wayne & Kothari, S. P, 2003. "How much do firms hedge with derivatives?," Journal of Financial Economics, Elsevier, vol. 70(3), pages 423-461, December.
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    More about this item

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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