Esoteric derivatives contribute to chaos on markets

The explosive growth of derivative products has played a role in increasing and spreading market irrationality and a movement away from fundamentals in influencing stock market traders. During the period 2000 to the collapse in 2007 -09 this explosion of artificial tradable collateralized debt obligations including synthetic portfolios and other exotica like credit default swaps greatly exaggerated the impact of the collapse of the housing bubble. This may well have happened during the most recent stock market swoon driven in part by shenanigans in short selling the volatility index, the VIX which we must note is constructed using the implied volatility of a wide range of the S&P 500 index from both calls and puts.The index is expectations driven and is not the literal variance but rather the implied variance based on the premiums that investors are willing to pay for the right to buy or sell stocks.The VIX takes the weighted average of all the option prices and attaches a single number to them which is called the VIX. For example if the VIX is 22 that means that the S&P is expected to stay within plus or minus 22 % range over a year a percentage of the time which represents one standard deviation. So clearly very few investors will understand how contingent and uncertain this product is nor also that it is expectations based and there is a built in margin of considerable error given the uncertain nature of probability. Choosing to short an index like this is a very risky strategy and it can and did backfire badly spreading its negative sentiment and panic selling. Further regulatory reform is in order.


About haroldchorneyeconomist

I am Professor of political economy at Concordia university in Montréal, Québec, Canada. I received my B.A.Hons (econ.&poli sci) from the University of Manitoba. I also completed my M.A. degree in economics there. Went on to spend two years at the London School of Economics as a Ph.D. student in economics and then completed my Ph.D. in political economy at the University of Toronto. Was named a John W.Dafoe fellow, a CMHC fellow and a Canada Council fellow. I also was named a Woodrow Wilson fellow in 1968 after completing my first class honours undergraduate degree. Worked as an economist in the area of education, labour economics and as the senior economist with the Manitoba Housing and Renewal Corporation for the Government of Manitoba from 1972 to 1978. I also have worked as an economic consultant for MDT socio-economic consultants and have been consulted on urban planning, health policy, linguistic duality and public sector finance questions by the governments of Manitoba, Saskatchewan,the cities of Regina and Saskatoon, Ontario and the Federal government of Canada. I have also been consulted by senior leaders of the British Labour party, MPs from the Progressive Conservative party, the Liberal party and the New Democrats on economic policy questions. Members of the Government of France under the Presidency of Francois Mitterand discussed my work on public sector deficits. I have also run for elected office at the municipal level. I first began to write about quantitative easing as a useful policy option during the early 1980s.
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