Capital markets across the globe have grown dramatically over the past several decades. This growth was spearheaded by derivative financial instruments that have undergone a stunning transformation over the past 30 years. A wide variety of derivatives trades nowadays alongside stocks and bonds on a number of centralized exchanges as well as on the over-the counter market via dealer networks.
Derivatives have grown in every market they have been introduced to, both in terms of the size of the market and the variety of products offered. Moreover, this fast-pace growth does not appear to have tapered off. Growth opportunities also exist because much of the world still lacks well developed derivatives markets.
Derivatives accelerate the integration of global capital markets in part by providing an efficient means of redistributing risks across market participants. Such redistribution augments the aggregate risk-taking capacity and lowers the cost of risk. Despite the rocket-scientist flavor, derivatives are by no means new to the field of finance. Some of these products such as forwards and futures have existed for centuries.
The market for rice futures existed in the 17th-century Japan, while forwards on tulips played an integral role in the Dutch tulip mania in 1630’s. Derivatives markets received a boost in 1973 with the opening of the Chicago Board of Option Exchange and the publication of the Black and Scholes option-pricing model. Swaps gained popularity in the early 1980’s and credit derivatives appeared in the early 1990’s and now constitute the fastest growing segment of the derivatives market.