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Modern Financial Systems: Theory and Applications by EDWIN H. NEAVE

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CHAPTER 12
Markets for Trading Risks
This chapter begins by introducing the types and importance of risk trading activity, then examines how risk trading differs between the options and futures markets. Next, it examines several issues of market evolution, including the development of the markets for catastrophe bonds, market mergers, the convergence of financial and insurance markets, and developments in the over-the-counter markets.

INTRODUCTION

This chapter examines the markets for trading risks. Applying the ideas of governance developed in Chapters 5 and 6, along with the pricing theories developed in Chapters 8 and 9, the present chapter explains how and why risks are traded in practice. It examines the options and futures markets’ economic similarities and differences, and explains why risk trading has grown at such phenomenal rates since the early 1970s. It also explains that intermediaries trade risks in the over-the-counter (OTC) markets, sometimes acting as principals and holding one side of the transaction on their own books, at other times acting only as agents (i.e., brokers). The last part of the chapter points out that markets for risk trading are continuing to evolve in a number of ways. New instruments continue to be created, risk trading by banks and insurance companies continue to converge, and clearing houses are being set up for the over-the-counter markets.

Why Risks Are Traded

In one form or another, risks are traded in virtually every economy. However, ...

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