Is the Derivatives Business Too Big?

Abstract

While acknowledging the theoretical and practical importance of derivatives pricing models, White is puzzled by the tremendous amount of trading, especially within the financial sector (rather than between financial intermediaries and end-users) in zero-sum instruments that are supposed to be redundant. One possible explanation is that because risk exposure and the “fair” return on a derivative are conceptually hard to pin down, many derivatives investors may not be assessing risk exposures correctly. If so, better risk measures should lead to less trading in derivatives markets.

TOPICS: Derivatives, VAR and use of alternative risk measures of trading risk, exchanges/markets/clearinghouses