Risk transfer is the traditional business of insurers. But governments
are in direct competition not only with insurance companies - but also
with the capital markets. Futures, forwards, and options contracts are,
in effect, straightforward insurance policies.
They cover specific and narrowly defined risks: price fluctuations - of
currencies, interest rates, commodities, standardized goods, metals,
and so on. "Transformer" companies - collaborating with insurance firms
- specialize in converting derivative contracts (mainly credit default
swaps) into insurance policies. This is all part of the famous
Keynes-Hicks hypothesis.
As Holbrook Working proved in his seminal work, hedges fulfill other
functions as well - but even he admitted that speculators assume risks
by buying the contracts. Many financial players emphasize the risk
reducing role of derivatives. Banks, for instance, lend more - and more
easily - against hedged merchandise.
Hedging and insurance used to be disparate activities which required
specialized skills. Derivatives do not provide perfect insurance due to
non-eliminable residual risks (e.g., the "basis risk" in futures
contracts, or the definition of a default in a credit derivative).
Pages:
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82