Health Insurance Derivatives: The Newest Application of Modern Financial Risk Management

By Hayes, James A.; Cole, Joseph B. et al. | Business Economics, April 1993 | Go to article overview

Health Insurance Derivatives: The Newest Application of Modern Financial Risk Management


Hayes, James A., Cole, Joseph B., Meiselman, David I., Business Economics


WE ARE IN the midst of a giant economic, business and financial revolution, particularly with respect to understanding and managing risk and uncertainty. The revolution is worldwide and is an important factor in globalizing markets. This revolution has significantly changed the way businesses and financial firms are managed, the way markets, products, and services are structured and analyzed, and the way economists and financial experts perform their analytical and operating tasks.

According to estimates of the Futures Industry Association, the 1990 volume of exchange-traded financial derivatives was double that of 1985 and almost seven times the 1983 volume. Derivative exchanges spread to the world's major financial centers, such as London, Paris, Tokyo, and Singapore, and in the U.S. from Chicago to New York and Philadelphia. The growth of the over-the-counter (OTC) financial derivatives has been extraordinary. Prior to the 1980s, the primary OTC market was the interbank foreign exchange market, involving forward currency contracts. In the 1980s, the growth in the OTC market was based on innovative financial engineering, resulting in a host of new instruments such as swaps, caps, floors, collars, and swaptions. The International Swap Dealers Association (ISDA) estimates that in 1987 outstanding currency and interest rates swaps totaled almost $1 trillion. By 1990, only three years later, these swaps tripled to close to $3 trillion.

What accounts for this phenomenal growth, and what are some of its effects? First and foremost, the markets in derivatives have grown because these markets present a better and a cheaper way to manage risk and to design useful, innovative products. The main elements of how price risks in agricultural markets could be managed or hedged were well-known many years ago, as was the related price discovery function of futures markets, i.e., as a by-product of markets for future delivery, prices in those markets could be seen by all. People therefore could easily "discover" the market's judgments about future price as well as the prices at which transactions for deferred delivery could be executed today. The ability to do these trades was made accessible to a wide range of people; the market determined the price of the contract, which was the same to all.

The wave of innovation really began once it was recognized that essentially the same analysis and risk management techniques applicable in commodities futures markets were appropriate to financial markets as well. David Meiselman's research more than thirty years ago was path-breaking and was published in his The Term Structure of Interest Rates (Prentice-Hall, 1962).

Risk reduction and management opportunities afforded by derivatives reduce the cost of achieving a desired or optimal level of risk. Risk became something to be managed and controlled and a central matter for sophisticated, responsible management. Price discovery gives ultimate transactors and wealth holders the ability to dispose of some or all of the risk by appropriate buying or selling. In addition, risk can be shifted to those who prefer to carry these risks or who are effectively paid to do so. The result is a more efficient allocation of risk, with resulting overall wealth and income gains that more than compensate for added transactions costs.

These results came in three major phases:

1. In the first phase of the growth of derivative instruments and markets, especially exchange-traded futures, the number and use of these instruments and markets increased enormously, including Treasury bonds of various maturities, foreign exchange, short-term money market instruments such as Euro-dollars and now even the federal funds rate. During this time, there was a parallel development of options markets, first on individual stocks, then options on futures and currencies, and then options on various indexes. The put-call parity conditions tied together the options, spot and futures markets. …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Health Insurance Derivatives: The Newest Application of Modern Financial Risk Management
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Author Advanced search

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.