The Development of Global Financial Product Derivative Markets

The development of global financial product derivative markets is a broad and complex topic that involves many aspects of financial economics, such as risk management, financial innovation, market efficiency, regulation, and systemic stability. Derivatives are financial instruments whose payoffs derive from other, more primitive financial variables such as a stock price, a commodity price, an index level, an interest rate, or an exchange rate. Derivatives can be used to hedge an existing market exposure, to obtain downside protection or upside potential, to transform the nature of an exposure, or to obtain insurance against events such as default.

The global derivatives market is an immense one, with a notional amount outstanding of over $700 trillion in both over-the-counter (OTC) and exchange-traded markets. The growth of derivatives usage over the last few decades has been driven by several factors, such as:

• The increased volatility and uncertainty in the global financial markets, which created a greater demand for risk management and diversification.

• The globalization and integration of the world economy, which increased the cross-border flows of trade, investment, and capital, and the exposure to foreign exchange and interest rate risks.

• The financial innovation and technological advancement, which enabled the creation of new and complex derivatives products, such as credit derivatives, structured products, and exotic options.

• The regulatory and institutional changes, which affected the incentives and constraints of the market participants, such as the Basel capital adequacy framework, the Dodd-Frank Act, and the European Market Infrastructure Regulation.

The development of global financial product derivative markets has also brought some challenges and risks, such as:

• The lack of transparency and standardization in the OTC derivatives market, which made it difficult to assess the market size, structure, and risk exposures.

• The counterparty risk and systemic risk, which arose from the interconnectedness and interdependence of the market participants, and the potential for contagion and spillover effects in times of stress.

• The operational risk and legal risk, which resulted from the complexity and diversity of the derivatives contracts, and the possibility of disputes, errors, or frauds.

Therefore, the development of global financial product derivative markets requires a careful balance between the benefits and costs of derivatives, and a prudent and effective regulation and supervision of the market activities. The main objectives of the regulators and policymakers are to ensure that derivatives transactions are properly traded, cleared, reported, and monitored, and that the market participants are adequately informed, educated, and protected.