[T]hese new financial instruments are an increasingly important vehicle for unbundling risks … [They] enhance the ability to differentiate risk and allocate it to those investors most able and willing to take it … a process that has undoubtedly improved national productivity growth and standards of living .
Alan Greenspan (1999)
I view derivatives as time bombs, both for the parties that deal in them and the economic system … these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear. Central banks and governments have so far found no effective way to control, or even monitor, the risks posed by these contracts. In my view, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal .
Warren Buffett (2002)
Derivatives in modern economics are like nuclear energy in modern science; a source of immense power, which can also be the cause of enormous destruction. Derivatives (albeit not by that name) have been in existence for a long time, with forward trading in rice in Japan in the seventeenth century, being the first documented example, but their economic significance has increased enormously in recent years.
As of June 2013, according to data from the Bank for International Settlements (BIS), the total notional amount outstanding on derivative contracts was $762 trillion 3 , i.e., $762,000 billion or $7.62 ' 10 14 (see Table 1.1). This includes ‘Over The Counter’ (OTC) contracts between two counterparties and contracts traded in recognized exchanges (‘Exchange Traded Derivatives’ or ETD). At $52.5 trillion, the notional amount of derivatives contracts traded in recognized exchanges amounted to just over 8 per cent of the total with OTC contracts making up 92 per cent. However, the BIS data excludes exchange-traded futures and options on commodities , and on individual shares for which data on a reliable comparable basis was not available. This figure therefore substantially underestimates the total volume of derivatives trading.