Comment by rcme
3 years ago
Risk management is the product. Surely you agree that a product that reduces risk is worth something, right?
3 years ago
Risk management is the product. Surely you agree that a product that reduces risk is worth something, right?
Sure I’m pro-risk management. So by arbing lending-rates which risks are mitigated?
E.g. interest rate risk. Maybe I've sold a bunch of variable-rate bonds before. But now I am worried about interest rates rising. I can't call the bond for some reason (maybe not enough money, maybe some regulatory reason). So I buy an interest rate swap that pays out if interest rates rise.
This isn't false but it feels reductive. A financial instrument that allows one to bet on the corn harvest is obviously valuable to the corn farmer, as it allows them to use profits from good seasons to hedge against bad seasons. They're also valuable to people whose business is affected by the corn harvest - cereal manufacturers, say. The problem is that they can also be used by people with no exposure at all who simply want to bet on the corn harvest, and from the scale of the finance sector it seems like we are pouring a lot more of our resources and brainpower in to designing exotic new ways to bet on the corn harvest than we are on growing corn.
> as it allows them to use profits from good seasons to hedge against bad seasons
It allows corn farmers to grow wheat instead, because he is selling it right now and wheat is more profitable right now.
The main reason why it doesn't go astray and make people hungry is because people that isn't involved in any way can go, study the factors that make wheat more profitable to corn, do their predictions of what will be the case at the point of delivery, and if they predict correctly that the price is wrong they can go and adjust it making a lot of money on the process.
I'm not sure how this is related to my post so perhaps I was unclear. I'm not talking about individual corn farmers and the choices they make, I'm talking about how we as a society and an economy allocate our resources. I'm saying that derivative financial instruments have value, for the reasons I suggested and the others described by sibling commenters, but that the finance sector is larger than that value warrants.
I'm not sure why I'm being downvoted, as I didn't think this is all that controversial. Historically, finance was a much more boring and less lucrative field than it is now, and consequently much smaller. "I'm a super smart 18 year old and I want to get rich, so obviously I should go into banking" is a relatively recent phenomenon. I agree with everyone else here that the industry has value, so presumably its recent explosion in size has brought some additional value, but it's very hard to believe that value is large enough to offset the opportunity cost of a generation of ambitious geniuses not going in to science or industry or becoming entrepreneurs.
The buyers and sellers of a futures contract are both trying to offload risk onto someone else. The risk profiles of both sides don’t always offset exactly, so speculators are necessary for functioning commodity futures markets (and markets in general). Also, price discovery is much more efficient with more liquidity, which is what speculators provide, in addition to risk assumption.
Sure, I get this and agree, but price discovery and facilitating markets are subject to diminishing returns just like anything else, right? I don't think I would've been downvoted for saying something like, "It's a problem that it's more lucrative to speculate on existing housing than to build new housing, so we should make regulatory changes to address that" and this feels analogous to me.
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