Controversies in using derivatives in the context of the financial crisis

Abstract

As a phenomenon, risk is specific for any human activity. Following this logic, we can say that this concept is a constituent element in the definition given to the financial sector, investments and market competition. The questions that the whole range of operators (governments, regulation bodies, financial institutions, companies and shareholders) must answer are: Which type of risk should one assume within an economic entity and to what extent should that risk be taken? And if risk is materialized, to what extent will the financial consequences affect the involved parties? Working in this environment, the financial and economic agents’ behaviour has significantly been modified, that is, it has mitigated the degree of risk aversion. The solution for this is establishing more flexible regulation lines that do not have as a main objective the elimination of failure, but rather the reduction of frequency with which such incidents occur and to manage the individual investors/consumers’ losses. One must preserve a balance between the need for facilitating risk internalization and the efficient use of capital (a fundamental operation for maintaining competitiveness and innovation spirit) on the one hand, and maintaining a certain protection level for the investor/client on the other hand. Key words: Risk internalization, derivatives, collateralised debt obligation (CDOS), credit default swap (CDS), financial transaction taxes, Paul Volker’s financial theories, the Tobin tax.