Derivatives and the Financial Crisis of 2008: Managing Risk, Creating Risk, and Regulations

Exchange-traded derivatives, i.e., futures and options are the most powerful financial instruments in financial markets for hedging policies aimed at managing the price risks which are originated in physical markets as well as for speculative strategies. after a brief reference to the nature of these instruments, we have shown in this paper that derivatives, which are basically advanced innovations in financial studies, can be extremely risky and complex in practice, hence may be considered as a constant threat to international financial stability. despite the presupposition of financial economists that innovation is the engine of growth and “capitalism’s foundational energy”, we have concluded that the widespread application of derivatives during the past two decades together with the complexities of hedging and speculation strategies, which can be misused by financial investors, can be considered as one of the main causes of the failure in market discipline mechanism which manifested in the financial crisis of 2008 and its aftermath. the effectiveness of financial regulation is a challenging question which naturally arises in this context.