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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

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    Cited by:

    1. Pradier Pierre-Charles M., 2011. "Administering Systemic Risk vs. Administering Justice: What Can We Do Now that We Have Agreed to Pay Differences?," Accounting, Economics, and Law: A Convivium, De Gruyter, vol. 1(1), pages 1-6, January.
    2. Tadanori Yosano & I Wayan Nuka Lantara, 2010. "Bank-firm relationship and the use of derivatives in japan," Discussion Papers 2010-58, Kobe University, Graduate School of Business Administration.
    3. Mark Carey & René M. Stulz, 2007. "The Risks of Financial Institutions," NBER Books, National Bureau of Economic Research, Inc, number care06-1, April.
    4. Mariano Graziano, 2012. "Italian nonfinancial firms and derivatives," Questioni di Economia e Finanza (Occasional Papers) 139, Bank of Italy, Economic Research and International Relations Area.
    5. Turner, Peter A. & Lim, Siew Hoon, 2015. "Hedging jet fuel price risk: The case of U.S. passenger airlines," Journal of Air Transport Management, Elsevier, vol. 44, pages 54-64.
    6. Carruthers, Bruce G., 2013. "Diverging derivatives: Law, governance and modern financial markets," Journal of Comparative Economics, Elsevier, vol. 41(2), pages 386-400.
    7. Wall, Larry D. & Eisenbeis, Robert A. & Frame, W. Scott, 2005. "Resolving large financial intermediaries: Banks versus housing enterprises," Journal of Financial Stability, Elsevier, vol. 1(3), pages 386-425, April.
    8. Abdullah, Azrul & Ku Ismail, Ku Nor Izah, 2015. "Hedging Activities Information and Risk Management Committee Effectiveness: Malaysian evidence," MPRA Paper 85026, University Library of Munich, Germany.
    9. Florence Guillaume & Wim Schoutens, 2012. "Calibration risk: Illustrating the impact of calibration risk under the Heston model," Review of Derivatives Research, Springer, vol. 15(1), pages 57-79, April.
    10. Kim, Young Sang & Mathur, Ike & Nam, Jouahn, 2006. "Is operational hedging a substitute for or a complement to financial hedging?," Journal of Corporate Finance, Elsevier, vol. 12(4), pages 834-853, September.
    11. Behrouz LariSemnani & Reihaneh Benesloo, 2015. "Ranking of Hedging Tools from the Perspective of Tehran Stock Exchange Investors," Asian Economic and Financial Review, Asian Economic and Social Society, vol. 5(7), pages 926-940, July.
    12. Mayordomo, Sergio & Rodriguez-Moreno, Maria & Peña, Juan Ignacio, 2014. "Derivatives holdings and systemic risk in the U.S. banking sector," Journal of Banking & Finance, Elsevier, vol. 45(C), pages 84-104.
    13. Entrop, O. & von la Hausse, L. & Wilkens, M., 2017. "Looking beyond banks’ average interest rate risk: Determinants of high exposures," The Quarterly Review of Economics and Finance, Elsevier, vol. 63(C), pages 204-218.
    14. Kjell Sümegi & Peter Haiss, "undated". "The Relationship of Insurance and Economic Growth - a Theoretical and Empirical Analysis," EcoMod2006 272100091, EcoMod.
    15. Trapp, Rouven & Weiß, Gregor N.F., 2016. "Derivatives usage, securitization, and the crash sensitivity of bank stocks," Journal of Banking & Finance, Elsevier, vol. 71(C), pages 183-205.
    16. W. Scott Frame & Lawrence J. White, 2005. "Fussing and Fuming over Fannie and Freddie: How Much Smoke, How Much Fire?," Journal of Economic Perspectives, American Economic Association, vol. 19(2), pages 159-184, Spring.
    17. Lau, Chee Kwong, 2016. "How corporate derivatives use impact firm performance?," Pacific-Basin Finance Journal, Elsevier, vol. 40(PA), pages 102-114.
    18. Gabriel A. Giménez-Roche, 2011. "Institutional Illusion and Financial Entrepreneurship in the European Debt Scheme," Chapters,in: Institutions in Crisis, chapter 1 Edward Elgar Publishing.
    19. Calice, Giovanni, 2011. "The Impact of Collateral Policies on Sovereign CDS Spreads," ECMI Papers 12234, Centre for European Policy Studies.
    20. Nevi Danila & Chia-Hsing Huang, 2016. "The determinants of exchange rate risk management in developing countries: evidence from Indonesia," Afro-Asian Journal of Finance and Accounting, Inderscience Enterprises Ltd, vol. 6(1), pages 53-67.
    21. Ricardo Santos & Samuel Pereira & Elísio Brandão, 2016. "Transfer Pricing Aggressiveness And Financial Derivatives Practices: Empirical Evidences From United Kingdom," FEP Working Papers 583, Universidade do Porto, Faculdade de Economia do Porto.
    22. Donohoe, Michael P., 2015. "The economic effects of financial derivatives on corporate tax avoidance," Journal of Accounting and Economics, Elsevier, vol. 59(1), pages 1-24.
    23. Kristine Watson Hankins, 2011. "How Do Financial Firms Manage Risk? Unraveling the Interaction of Financial and Operational Hedging," Management Science, INFORMS, vol. 57(12), pages 2197-2212, December.
    24. Gatopoulos, Georgios & Loubergé, Henri, 2013. "Combined use of foreign debt and currency derivatives under the threat of currency crises: The case of Latin American firms," Journal of International Money and Finance, Elsevier, vol. 35(C), pages 54-75.
    25. Lim, Siew Hoon & Hong, Yongtao, 2014. "Fuel hedging and airline operating costs," Journal of Air Transport Management, Elsevier, vol. 36(C), pages 33-40.

    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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