Risks in Derivatives Markets: Implications for the Insurance Industry

J. OF RISK AND INSURANCE, Vol. 64 No. 2, June 1997

Posted: 11 Sep 1997

See all articles by Ludger Hentschel

Ludger Hentschel

Alternative Risk Premia Investments

Clifford W. Smith

Simon Graduate School of Business, University of Rochester

Abstract

We model default risk in derivative contracts. Firms are less likely to default on derivatives than on corporate bonds because bonds are always liabilities, while derivatives can be assets. We provide an upper bound for default risk in derivatives, one substantially lower than appears to be implied by public debate over derivatives. Systemic risk is the aggregation of default risks; since default risk has been exaggerated, so has systemic risk. Finally, public debate over derivative risks seems to ignore what we call "agency risk." Without careful monitoring, standard compensation plans for derivatives traders can induce traders to take inappropriately risky positions.

JEL Classification: G13, G24

Suggested Citation

Hentschel, Ludger and Smith, Clifford W., Risks in Derivatives Markets: Implications for the Insurance Industry. J. OF RISK AND INSURANCE, Vol. 64 No. 2, June 1997, Available at SSRN: https://ssrn.com/abstract=11139

Ludger Hentschel

Alternative Risk Premia Investments ( email )

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Clifford W. Smith (Contact Author)

Simon Graduate School of Business, University of Rochester ( email )

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Rochester, NY 14627
United States
585-275-3217 (Phone)
585-442-6323 (Fax)

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