FINANCIAL DERIVATIVES IN STOCK MARKET STABILITY: A REVIEW

Priyanka Jha

Abstract


Financial derivatives are fundamental to modern financial markets and play a crucial role in managing risk, enhancing liquidity, and facilitating efficient price discovery.  This study explores their impact on the stability of stock markets by examining their historical development, primary functions, and various types, including futures, forwards, options, and swaps. This study synthesizes historical case studies, empirical research, and regulatory policies to evaluate both the stabilizing and destabilizing effects of derivatives. By analyzing financial crises like the 1987 stock market crash and the 2008 financial crisis, the review illustrates how excessive leverage, lack of transparency, and regulatory shortcomings have heightened systemic risks in the past. Conversely, when utilized for hedging and liquidity management, derivatives can contribute to more stable market operations, lower transaction costs, and improved capital allocation. The review also investigates the regulatory frameworks implemented by the CFTC, SEC, and international regulators aimed at mitigating risks and ensuring financial stability. Key regulatory measures like centralized clearing, stricter capital requirements, and enhanced transparency; have played a significant role in reducing counterparty risk and preventing market disruptions.

This review provides a comprehensive evaluation of financial derivatives by integrating historical, empirical, and regulatory insights, offering a balanced perspective on their role in stock market stability. The findings highlight the importance of strong regulatory oversight as a vital safeguard against potential risks while acknowledging the evolving complexities introduced by financial innovation.


Keywords


Financial Derivatives, Stock Market Stability, Risk Management, Liquidity, Regulatory Framework, Systemic Risk, Empirical Analysis, Financial Innovation

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