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OTC derivatives
Growth in the over-the-counter (OTC) derivatives market reverted to a pace in line with the long-term average in the second half of 2006. Notional amounts increased by 12% to $415 trillion at the end of December, after rising 24% in the first half of the year. 9 Growth remained very strong in the credit segment, but fell to rates in the range of 5–11% in other risk categories. Gross market values, which measure the cost of replacing all existing contracts and thus represent a better measure of the size of the exposures at a given point in time than notional amounts, remained roughly stable at $10 trillion at the end of December 2006. This reduces to $2 trillion if netting agreements are taken into account.
The market for credit default swaps (CDSs) continued to expand at a fast Rapid increase in CDS positions pace in the second half of 2006. At 42%, the rate of growth was only marginally below the 46% recorded in the first half of the year (Graph 5). With a cumulative volume of $1.7 trillion 10 between July and December, multilateral terminations of CDS contracts were of a similar volume as in the first half of the year and shaved approximately 8% off the rate of growth in this market. The currency breakdown of OTC foreign exchange derivatives provides Only mixed evidence for only very mixed support for an expansion of carry trades during the period increase in carry under review. 11 The notional amounts of contracts on the yen changed little trade activity over the period, suggesting that carry trades were not an important driver of activity in that market segment. By contrast, positions in the Swiss franc, widely considered to be the second funding currency behind the yen, increased by 10%, thus outpacing the growth of the market as a whole. Turning to potential target currencies, the volumes outstanding of contracts on sterling expanded by 17%, which may partly reflect carry trade activity. However, important caveats have to be borne in mind when using the BIS semiannual survey to track carry trade activity. First, the low frequency of the data and the coarse instrument breakdown make it difficult to separate carry trades from trades based on different motives. Second, the data are less than comprehensive for non-G10 currencies such as the Australian dollar, because local banks do not form part of the reporting population. In addition, some activity in non-G10 currencies might be captured under “other currencies” since reporting dealers do not have to identify positions in these currencies.
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I have no idea what this says
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Concentration in the OTC derivatives market appears to have increased since the survey was established in 1998, although it remains low on average (Graph 6). The Herfindahl indices (HIs) for FX and interest rate derivatives in the major currencies are in the range of 400 to 700, below the level that most economists would consider as indicating an oligopolistic market. For example, an HI of 500 would correspond to 13 dominant firms, assuming that the remaining reporting dealers shared equally the other 20% of the market. A market with nine dominant firms of equal size and a joint market share of 80% would have an HI of just over 700. However, while concentration tends to be low on average, it is quite high in some smaller markets. For example, the HI of forward rate agreements in yen increased from under 2,000 in the first half of the decade to almost 3,500, which would correspond to the case of three firms with equal market share accounting for 100% of the market. Nevertheless, not all small markets display such a high degree of concentration. For example, the HIs for interest rate swaps in Swedish kronor are the second lowest in the swaps segment behind the euro, and are much lower than those for swaps in Canadian dollars or Swiss francs, whose markets are of comparable size.
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With my limited knowledge of OTC Derivatives, I would guess that the $700 trillion figure cited by the author is an exageration of the OTC Derivative problem.
Ok, color me an idiot - what, exactly, is a derivative?