Articles

Human Risk And The Pervasiveness Of Index Derivatives
By Jonathan Citrin

Page 2 of 5

The influence of index-based derivatives on underlying assets has been a source of great discord through recent history and may never be agreed upon. Significant evidence exists that both favors and condemns the influence of index-based derivatives on the investments they track. Much recent research, time and money has been spent disputing the effect of index-based derivatives on the volatility of underlying indexes, not to mention considerable efforts expended to determine the role of index-based derivatives in major market crashes, including the Great Recession of 2008 and October 1987’s Black Monday. However, commentary on and academic assessment of the very existence of index-based derivatives and the implications of the still-growing popularity of these complex risk mitigation, arbitrage and speculation instruments are both in short supply.

Analysis And Interpretation
According to the Bank for International Settlements, the notional value of global derivatives traded over-the-counter (OTC) as of December 2011 was nearly $648 trillion, with gross market values of over $27 trillion. The notional value of derivative instruments traded on organized exchanges as of December 2011 reached almost $56.5 trillion, with equity index-based derivatives reaching roughly $3 trillion (Bank for International Settlements 2012). See Figures 2-4.