Latin American Capital Markets

346 A. M. CORCORAN, R. B. HOBSON, G.J. KUSERK, K. K.WUERTZ.AND D.WESTliquid cash market. Such conditions are conducive to transparent markets and can ensurea source of asset supply essential to avoiding squeezes where the derivativescontract relies on delivery at contract expiration. As volume or turnover drops, evena large outstanding supply of the asset may not be adequate to overcome potentialcongestion or manipulation in the derivatives contract.This factor is especially importantin Latin America, where many cash markets are not fully developed, are broadlydispersed, or lack depth. Too small a supply of an asset may render it susceptible tomanipulation even where the volume of trading is typically high.Related to market size is the organization of the underlying market, such asthat for financial assets. 10 Often market organization affects trading volume and thesupply of financial assets. In terms of market organization, the number of issuers, concentrationof issuers, and patterns of issuance and investment are the most importantattributes to consider For example, there may be one or many issuers of debt instrumentderivatives, depending on how the class of underlying cash instruments isdelimited. For government debt, there usually is a sole issuer of the underlying asset.In such a case, important considerations include whether the issuer is a reliable sourceof supply for the asset and, if it is, whether the issuer can be expected to manipulatethe price of the asset 1 ' Where there are many issuers, control of supply is of less concern,although heterogeneity of the asset may adversely affect its potential risk managementuses.In addition to the overall number of issuers, the concentration among issuersmay also be of concern. As with having a small number of issuers, a high concentrationamong issuers would raise concerns over potential disruptions in the supply and pricingof the underlying assets.Thus, derivatives contracts on assets for which there is lowmarket concentration will be less susceptible to manipulative threats and may lead tomore viable derivatives contracts than on assets with high levels of issuer concentration.Finally, it is important to take into consideration the patterns of issuance andinvestment. Successful derivatives contracts usually rely on a regular; reliable source ofassets. Such a source serves several purposes. First, a steady supply leads to a moreefficient cash market so that investors can readily ascertain the value of their investments.This, in turn, aids in the pricing of derivatives contracts. Second, a steady sup-10 While cash settlement can be a technique for avoiding congestion, market size may also be an issue in finding ameans to price the settlement of cash-settled futures.1 ' IOSCO (2002a) includes an instructive appendix on the rate of economic growth; size and structure of the bondmarket; liquidity ratios; benchmark/government securities; legal, regulatory, and tax framework; corporate bonds; issuersand investors; macroeconomic policies; and market microstructure based on responses from several countries,including Argentina, Brazil, El Salvador; Peru, and Trinidad and Tobago.Copyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub