Question

Since derivative securities such as options, futures, and swaps are very risky, they have occasionally been criticized for having been the source of large losses by some corporations, investment funds, state and local governments, and other investors. Some believe that they just make the economy riskier. Some claim that the record-high oil prices are due to the speculation in the futures market. Some claim that subprime mortgage crisis was caused by the securitization of mortgages, which can be seen as a type of derivative securities. Do you agree?

Answer 1

Yes, I totally agree with the above statement. In wake of the recent crashes that we had we can say that the derivatives and speculation in it are the main reason for the markets to overheat and crash. We have the example of mortgage crisis during 2007-2008, also we have the example of oil markets.

The main risk is the derivate is just a contract between parties based on some underlying asset without in actual the asset being traded. This leds to multiple bets and leads to a bubble being created.

Now the spread in the contracts leads to speculation by the traders which ultimately inflates the underlying asset price.