Latin American Capital Markets

342 A. M. CORCORAN, R. B. HOBSON, G.J. KUSERK, K. K.WUERTZ,AND QWESTFigure 11 -1 I Traditional View of Derivatives Market Evolutionthe basis for such contracts, with even fewer leading to overwhelming success. 6 Whilemany factors related to the assets and markets for them play a role in the ultimatesuccess of a derivatives contract, derivative designers usually focus on the attributesof the assets and the liquidity of the underlying cash market to gauge the potentialsuccess of derivatives contracts.Ability to StandardizePolicymakers considering a derivatives market need to understand at the outset thatexchange contract design involves an exercise in trade-offs (table I I-2). This is becauseideally a contract should minimize basis risk, which increases the transactioncosts of hedging; but at the same time a contract should maximize liquidity. To maximizeliquidity and minimize credit risk some standardization is essential. Numerousfactors play a role in the balancing act necessary to provide precision without sacrificingliquidity and efficient credit management Some of these may be beyond the6 Even in the United States, as many as 80 percent of contracts proposed never result in a functioning market It isoften the second contract developed that is successful; in the case of the Chicago Board of Trade's development offinancial futures, the initial government agency contract did not succeed, but the later bond contract did.The ChicagoMercantile Exchange has had a similar experience with contract development.Copyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub