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Financial Institutions

In: Business and Management

Submitted By naomi08
Words 4021
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DEVELOPMENT OF DERIVATIVE MARKETS IN EMERGING MARKET COUNTRIES1 A. Background Derivatives are commonly used for managing various risk exposures, including foreign exchange, interest rate, and credit risks. By allowing investors to unbundle and transfer these risks, derivatives contribute to a more efficient allocation of capital, in many cases reduce market and portfolio volatility, facilitate cross-border capital flows, and create more opportunities for portfolio diversification. Despite rapid growth over the past several years, Emerging Market (EM) derivatives account for only about 10 percent of the total outstanding notional values in global derivatives markets. Compared to mature markets, the ratio of outstanding notional value of derivatives to market capitalization of the underlying asset markets is fairly small in most emerging economies and is mainly focused on sovereign risks. The most common issues that challenge the development of local derivatives markets are (i) relatively underdeveloped markets for the underlying assets; (ii) lack of adequate regulatory, legal and market infrastructure, and (iii) restrictions on the use of derivatives by local and foreign entities.2 The problem of misuse of derivatives is perceived to be more acute in emerging market countries where prudential regulation, credit information infrastructure, and risk management practices are not fully developed and maybe in conflict with reasonable economic, investment or portfolio objectives. This note provides a background for a discussion on policy measures to promote the benefits of derivative markets in EM countries, while acknowledging existing and forthcoming challenges. It is based on case studies of the development of derivative markets in Brazil, Chile, Hungary, India, Israel, Korea, Mexico and Poland. B. Current Stage of Development of EM Derivative Markets There are large...

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