The size on the overall
economy and adverse effects of the Great Depression of 1929 has fundamentally
transformed the economic theory. The depression had been triggered by a
dramatic decline in stock prices, immediately transmitted to the money and
capital markets, finally contaminated to the real economy and labor market. From
1930s to 1970s fiscal policy recommended by Keynesian approach had been
extensively used by the policy makers to stabilize and stimulate the economy.
1970s were suffering
period for not only the U.S. economy but for the most of advanced economies
because of the high inflation rates, unemployment, and decreasing corporate
profits. Monetarist approach recommended the monetary policy to deal with the
inflation problem. According to the researchers (Friedman and Schwartz, 1963) even
the Great Depression of 1929 had sourced from the wrong monetary policy.
The Great Recession of
2008 revived the unpleasant memories of the Great Depression of 1929. The size
of the Great Recession required a comprehensive government intervention to the
The causes of the Great Recession of 2008 has been studied, analyzed in
literature (Grusky and Wimer, 2011; Elsby and others, 2010). Also the role of
the financial derivatives is deeply questioned and discussed by the public
officials (FCIC, 2011).
The effects of the
financial derivative instruments on the economic growth worth to be studied in detail.
By the end of the 2016 the global OTC derivative contracts’ notional value is
about 482 trillion dollars (BIS, 2017). According to the World Bank the world’s
GDP for 2016 is about 75 trillion dollars (World Bank, 2017). The size of
exchange traded derivative contracts by the end of the 2016 is about 67
trillion dollars (BIS, 2017). The derivative contracts’ notional value is
almost ten times higher than the overall GDP of the world.
Second important issue
about the financial markets is related with the employees’ compensations. The
salaries and compensation plans have been widely discussed (FCIC, 2011), and it
has been defended that the high returns of the education attract the successful
students to the financial sector. The result of the study may guide the policy
makers, universities, and the students to determine the correct education
policy for the country, to organize the education institution and enriching the
study areas, and the making decisions on the return of education investment for
Third dimension of the
financial derivative is related with the taxation, since the countries uses tax
incentives to attract foreign investments. The financial derivative markets are
relatively new in developing countries, because the economy policy makers evaluate
a channel to reach the external funds, tax exemptions and exceptions are being
used in this sector. The result of the study may guide the policy makers to
decide levying taxes on derivative contracts.
The effects of financial
development more specifically do the use of financial derivative instruments in
an economy promote the economic growth? If there is a casual relationship between
the derivatives and the economic growth, can this relationship be analyzed in
terms of the derivative type. This is the main question of this research
proposal. The researches on the subject is relatively limited and the question
deserves to be studied in detail. This proposal consists of six sections.
Following the introduction section, the second makes a summary of literature
review. The third and fourth sections gives the theoretical and practical
dimensions of respectively the financial development and economic growth. Fifth
section tries to give information about the data and the model. Last section, includes
the policy recommendations.
The relationship between
the financial markets and the economic growth studied by many researchers. Pagano
(1993) studied the relationship between the financial intermediation and the
economic growth. Levine and Zervos (1998) studied the relationship between the financial
intermediary advancement, stock market and economic growth. De Gregorio and
Guidotti (1995) studied the empirical links between long-run economic growth
and financial development. Two researchers (Demetriades and Hussein, 1996) studied
the causal relationship between the financial development and the real GDP. Another
researcher (Goldsmith, 1969) studied the financial structure and economic
Arestis and others (2001)
studied the relationship between the stock market development and economic
growth. Demirguc and Levine (1996) examined the stock market expansion and the
economic growth. Even the relationship between the financial development and
economic growth studied widely in literature, the causal relationship between
the financial derivatives and economic growth has not been examined widely.
After the Great Recession of 2008 with being seen one of the sources of the
financial crisis the derivatives examined in a critical point of view.
Yuncu and others (2016)
examined the relationship between the stock indexed derivative (future) markets
advancement and economic growth. Haiss and Sammer (2010) studied the impact of
derivative markets on financial integration, risk, and economic growth. Aali-Bujari
and others (2015) and others examined the impact of derivatives markets on
economic growth through using panel data. Baluch and Ariff (2007) investigated
the relationship between the financial derivative instrument markets and
Theoretical Background: Why Financial Derivatives Matter?
A financial derivative
contract is an agreement between two economic agents or counterparts that the
contract’s value based on the value of another, underlying asset. The
underlying asset maybe from a market for immediate delivery or from another
derivative contract market. The distinctive feature of a financial derivative
contract can be seen from the definition is that the sides agreement on the
transfer of the underlying asset is delayed until sometime in the future
(Overdahl and Kolb, 2010).
Notional Amounts of Global OTC Derivative Contracts
(in trillion USD)
Source: Bank for International Settlements (BIS) Statistics Explorer
As of the end December
2016 OTC positions in derivatives are 482 trillion USD by the end of the end
June 2016 it was from 553 trillion USD (BIS, 2017).
From the Code of
to modern highly computerized financial markets derivative instruments have
been widely used for different purposes (Kummer and Pauletto, 2012). Those
reasons can be listed under two categories which motivate economic agents to
sign a financial derivative contract:
(i) Hedging. Individuals,
corporates, commercial banks, and even non-profit organizations may want to
guard their financial situation in case of unexpected changes in exchange
rates, interest rates, prices, or other assets which they have a relationship
with. The hedging is a kind of temporary shield against the market movement if
it is used correctly.
(ii) Making Profit.
Investors seek to maximize their earnings through price volatilities and
arbitrage opportunities. If an economic agent anticipates the price
fluctuations correctly, he can take a position in derivative financial
instruments to make profit. In addition, the investors may detect the different
prices for same equity in different markets.
The most common types of
financial derivatives are forwards, futures, options, and swaps.
(i) Future contracts are
the most common type of financial derivatives and exchange traded ones. This is
a contract between two economic agents that contract reflects a price of an
asset in the future. The sides fix the price of an asset or exchange rate at
the time of the contract. There are future contracts on commodities (grains,
metals, food), future contracts on currencies, future contracts on interest
bearing instruments, and future contracts on stock indexes.
(ii) Forwards are
non-standardized contracts signed by counterparts to buy or sell an underlying
asset at a specified time in future at a price the parts accepted at the time
of contract signed. Forward contracts are not traded at exchanges; thus,
forwards can be traded OTC. The sides fix the price of an asset or exchange
rate at the time of the contract.
(iii) Swaps are the
contracts between two economic agents that a certain amount of money or
interest rate transferred consecutively for an agreed period. There are two
main types of swaps: (a) Currency swap. (b) Interest rate swap. Despite the
underlying assets may be differ, its price is taken from a publicly available
(iv) Options are
contracts between two economic agents on a security at a preset price, prior to
the expiration date. The subject of the option contract could be everything,
such as stocks, currencies, goods, commodities i.e. The main difference from
future, forward, and swap is in an option contract the buyer or seller (changes
to type of the option contract) has an option to execute the contract or not.
The cost of buying an option is the seller’s premium which the buyer must pay
to obtain the option right. There are two types of option contracts: (a) Call
options. (b) Put options.
Those types of derivative
contracts are methods that create derivatives, but as it was stated above a
financial derivative’s value of price depends on an underlying asset. There are
derivatives may depend on five types of assets: (i) Equity derivatives. (ii)
Interest rate derivatives. (iii) Commodity derivatives. (iv) Foreign exchange
derivatives. (v) Credit derivatives.
Practical Front: Financial Derivatives and Economic Growth?
The functions in an
economy and impacts on an economy of the financial sector and financial
institutions are one of the deep-seated research are in economics. The main
functions of the financial sector and institutions shown by the Levine (1997)
– Information Costs
– Transaction Costs
– Mobilize Savings
– Allocate Resources
– Monitor Managers and Exert
– Facilitate the
Trading, Hedging, Diversifying & Pooling of Risk,
– Ease Trading of Goods,
Services and Contracts
Channels to Growth
– Capital Accumulation
The relationship between
the financial development and economic growth widely studied and there is no
consensus among the researchers on this subject. The different approaches have
been stated by Al Yousif (2002). The first approach is the “supply-leading”,
which defends that the financial development promotes the economic growth. The
financial intermediary institutions promote the economic growth through two
channels. Raising the efficiency of capital accumulation and in turn the
marginal productivity of capital (Goldsmith, 1969) and raising the savings and
so the investments. (McKinnon, 1973; Shaw, 1973) The second approach is demand
following and claims that the real side of the economy grows, its demand for
financial services increases, leading to the growth of the services. (Demetriades
and Hussein, 1996; Friedman and Schwartz, 1963) The third approach states that
the relationship between financial development and economic growth postulates that
the two variables are mutually casual, that is, the have a bidirectional
causality (Demetriades and Hussein, 1996; Greenwood and Smith, 1997). The
fourth view defends that financial development and economic growth are not
causally related (Lucas, 1988).
Yuncu and others (2007)
examined the relationship between futures market development and economic
growth and found that futures market development has a significant impact on economic
growth. In another study Yuncu and others (2016) found that there is a
relationship between stock indexed future contracts and real economy. Aali
Bujari and others (2015) examined the impact of the derivatives markets on
economic growth. Through using dynamic panel data, they found that derivatives
markets have a positive influence on economic growth.
Objectives and Methodology
aim of the study is to test the causal relationship between the financial
derivatives and economic growth. Financial derivative is an umbrella term
covers forwards, futures, options, and swap contracts. The rights and
obligations are different for each of the derivative types. Therefore, to
differentiate the derivative instruments in terms of their impact on the
economy and to show which type of derivatives should be chosen to promote the
economic growth. If the overall impact on the economic growth is defined and forecasted
the policy makers may use the results to adjust appropriate tax policies. If
the magnitude of the relationship is significant the university education and
research institutions may focus on the derivative market and maybe the individuals
may use the results in their career planning.
methods will be used in the study. The time series data will be obtained from
the official website of the Borsa Istanbul, Turkish Statistical Institute, and
Bank for International Settlements. The Granger Casuality test, Augmented
Dickey Fuller and Phillips Perron unit root tests will be applied to determine
the stationarity of derivative instruments and the real economy.
Estimated Schedule of the Study
paper will consist of 4 essays. The first essay will focus on the forwards and
futures and the economic growth. The second essay will examine the options and
the economic growth. The third essay will cover the swaps and the economic
growth. The last essay will try to test the overall derivatives markets and its
impact on the economic growth.
is estimated to start the study with the beginning of the February 2018. The
literature review will be done in the February. The data will be collected in
March 2018. The model and tests will be run in April 2018. By the end of the
May 2018 it is estimated to word the paper and send to the academic advisor. If
the advisor approves the paper is is planned to submit the paper to the
National Bureau of Economic Research.
Expected Results and Policy Recommendations
Great Recession of 2008 was the largest economic crisis the developed economies
have experienced and one major components of the market collapse was the
extensive and unregulated use of the financial derivative contracts.
size of the financial derivatives markets is huge and carry significant risk
factors for the overall economy. Because the derivative instrument is not
static, it is difficult to follow them simultaneously they have been created.
Therefore, if the net impact is negative on the GDP government should take
measures to keep the macroeconomic stability.
there is a positive relationship between the variables, the government may
establish a well regulated and good working institutions derivative market to
attract the foreign investors.
taxation on the derivatives may be redesigned in accordance with the capital
may allocate their sources to study the field in detail. The individuals may
use the results to determine their career options or the return of their
investments in education.
there is no statistically significant relationship between the variables
governments, education institutions, and the individual may rethink the
1 The American Recovery and Reinvestment
Act of 2009. Curious readers may reach the pdf version of the act via https://www.congress.gov/111/plaws/publ5/PLAW-111publ5.pdf
2 For further reading see A Short History of Derivative Security
Markets by Ernst Juerg Weber The University of Western Australia http://www.rdi.uwa.edu.au/__data/assets/pdf_file/0003/94260/08_10_Weber.pdf