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Research on Derivatives
Research on Derivatives
Derivatives are financial instruments that specify a transaction which occurs when specific conditions are met regarding an asset - and are thus derivative of those assets. Assets include commodities, equities, currencies, interest rates, and other economic components that fluctuate in value. Research on derivatives thus encompasses research on the underlying assets, as well as research concerning derivatives markets themselves, and research on the use of derivatives by investors. Most of the research on derivatives takes place within banks, which use derivative instruments extensively as part of their investment strategies, as well as within academic institutions.
Since derivatives is such a broad umbrella term, covering a whole class of diverse financial instruments, research on derivatives is also a broad field. Analysts, whether working within financial institutions or as consultants, tend to specialize in a particular asset class. Whether that class is equities, currencies, or anything else, derivatives evolve so rapidly that keeping up with the research is a continuous effort even if the specialty is narrow. New derivative instruments are introduced frequently, and their uses are diverse. Derivatives can be used to hedge, or mitigate risk, to speculate, thus in effect taking on risk, or some combination of the two in a packaged product. This complexity makes research on derivatives an area requiring a high amount of sophistication and skill.
Academic research on derivatives tends to focus on derivatives markets, and the factors that influence them. This includes trends in financial innovation and market behavior, as well as changes in the legislative environment, taxation issues, and other external factors influencing derivative trading. Because of the lag inherent in conducting academic research, these studies often cannot take the latest available information into account, but nevertheless contribute to a greater overall understanding of the workings of derivatives markets.
With the recent economic crises and market upheaval, derivative trading has been under a spotlight as a contributing factor to market instability. One argument holds that because derivatives are one step removed from assets, and yet derivative trading influences asset prices, there is potential for economic disruptions that stem from the derivatives markets. In other words, that derivatives have the potential to manipulate the prices of assets into economically unfavorable configurations. Another argument has to do with regulation, and the fact that financial innovation moves too rapidly to be effectively regulated. Regulators simply cannot keep up with new classes of derivatives, even if those derivatives are not in keeping with economic and financial policy. Research on derivatives is carried out by regulatory bodies for the purpose of ensuring compliance and drafting legislation, however, many hold that there are not enough resources for regulators to be truly effective.
New legislation and other government responses to the recent financial crises will almost certainly bring some changes to derivatives markets, and changes in how analysts and institutions conduct research on development are sure to follow. However, derivatives are powerful financial instruments that are key to investors’ management of risk, and they are certainly here to stay. Changes in derivative products and derivative markets are going to be extremely interesting to observe in the coming years.
