research topics on financial derivatives

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The proliferation of derivative assets during the past two decades is unprecedented. With this growth in derivatives comes the need for financial institutions, institutional investors, and corporations to use sophisticated quantitative techniques to take full advantage of the spectrum of these new financial instruments. Academic research has significantly contributed to our understanding of derivative assets and markets. The growth of derivative asset markets has been accompanied by a commensurate growth in the volume of scientific research. The Review of Derivatives Research provides an international forum for researchers involved in the general areas of derivative assets. The Review publishes high-quality articles dealing with the pricing and hedging of derivative assets on any underlying asset (commodity, interest rate, currency, equity, real estate, traded or non-traded, etc.).

Specific topics include but are not limited to:

econometric analyses of derivative markets (efficiency, anomalies, performance, etc.) analysis of swap markets market microstructure and volatility issues regulatory and taxation issues credit risk new areas of applications such as corporate finance (capital budgeting, debt innovations), international trade (tariffs and quotas), banking and insurance (embedded options, asset-liability management) risk-sharing issues and the design of optimal derivative securities risk management, management and control valuation and analysis of the options embedded in capital projects valuation and hedging of exotic options new areas for further development (i.e. natural resources, environmental economics.

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Introduction to Financial Derivatives: modeling, pricing and hedging

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• Derivatives
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T1 - Introduction to Financial Derivatives

T2 - modeling, pricing and hedging

AU - Schumacher, J.M.

N2 - Financial derivatives are widely used as instruments to modify exposures to various types of financial risk. Examples include call options on a stock index, interest rate derivatives such as swaptions, and credit derivatives. The theory of financial derivatives, as it has been developed in recent decades, is based on a mix of economic ideas and concepts from mathematics.The material in this Open Press textbook originates from notes for a course that the author has taught at Tilburg University for more than ten years, as part of the MSc program in Quantitative Finance and Actuarial Science. The text aims to provide students with an introduction to continuous-time models that are used to analyze derivative contracts in finance and insurance. Users are expected to have a solid background in standard calculus, linear algebra, and probability; prior experience with stochastic calculus, however, is not a prerequisite.

AB - Financial derivatives are widely used as instruments to modify exposures to various types of financial risk. Examples include call options on a stock index, interest rate derivatives such as swaptions, and credit derivatives. The theory of financial derivatives, as it has been developed in recent decades, is based on a mix of economic ideas and concepts from mathematics.The material in this Open Press textbook originates from notes for a course that the author has taught at Tilburg University for more than ten years, as part of the MSc program in Quantitative Finance and Actuarial Science. The text aims to provide students with an introduction to continuous-time models that are used to analyze derivative contracts in finance and insurance. Users are expected to have a solid background in standard calculus, linear algebra, and probability; prior experience with stochastic calculus, however, is not a prerequisite.

KW - Derivatives

KW - finance

KW - economy

KW - markets

KW - stock exchanges

U2 - 10.26116/openpresstiu-schumacher-04-2020

DO - 10.26116/openpresstiu-schumacher-04-2020

SN - 978-94-6240-612-4

BT - Introduction to Financial Derivatives

PB - Open Press TiU

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Financial derivatives are commonly used for managing various financial risk exposures, including price, foreign exchange, interest rate, and credit risks. By allowing investors to unbundle and transfer these risks, derivatives contribute to a more efficient allocation of capital, facilitate cross-border capital flows, and create more opportunities for portfolio diversification. Thus, financial derivatives are essential for the development of efficient capital markets. However, just like any other complex financial instrument, derivatives may and, in fact, have at times been used by market players to take on excessive risk, avoid prudential safeguards, and manipulate accounting rules. For example, in the absence of adequate internal risk control and prudential supervision, derivative instruments may allow a company to take on excessive leverage by shifting certain exposures off balance sheets. Although the problem of misuse of derivatives is perceived to be more acute in emerging market countries where prudential regulation, credit information infrastructure, and risk management practices are not fully developed, it is certainly not limited to these countries. In a world of constantly evolving financial instruments, the design of prudential regulations that create incentives for market participants to use derivatives appropriately remains one of the biggest challenges for regulators in both mature and emerging markets.

This chapter provides an overview of local derivatives markets in emerging economies and focuses on two issues: how the use of derivatives facilitated capital flows to emerging economies and what was the role of derivatives in past emerging market crises.

Overview of Derivatives Markets in Emerging Economies

Despite rapid growth over the past several years, emerging market derivatives account for only 1 percent of the total outstanding notionals in global derivatives markets. Local derivatives markets in emerging economies differ greatly in their sizes, both in absolute terms and relative to cash markets. Compared with mature markets, the ratio of outstanding notional value of derivatives to market capitalization of the underlying asset markets is fairly small in most emerging economies (see Table 9 ). The most common problems that constrain the development of local derivatives markets are (1) relatively underdeveloped markets for underlying instruments; (2) weak/inadequate legal and market infrastructure, and (3) restrictions on the use of derivatives by local and foreign entities.

Notional Amounts Outstanding of the Over-The-Counter and Exchange-Traded Derivatives

(In billions of U.S. dollars; end-June, 2001)

• Currency Derivatives

Most of the currency derivatives trading around the world takes place in the over-the-counter (OTC) markets, with foreign exchange swaps accounting for more than two-thirds of the turnover. The turnover in global currency markets followed a declining trend from 1998 and up until early 2001 due to the introduction of the euro, expansion of E-broking, and banking sector consolidation. By contrast, during the same period, the turnover in the emerging foreign exchange spot and derivatives markets increased, with the share of emerging market currencies (including the Hong Kong SAR and Singapore dollars) in the global foreign exchange spot market turnover rising to 8.6 percent in April 2001 from 5.5 percent in April 1998 (see Table 10 ). The declining trend in global currency markets was reversed during 2001–02, as the volume of euro/dollar contracts, which replaced the European legacy currency contracts, gradually increased and the volatility of G-3 currency pairs rose sharply in the first half of 2002. As a result, the total notional value of outstanding contracts in global OTC foreign exchange derivatives markets reached $18.5 trillion as of end-2002, approaching the mid-1998 level ($18.7 trillion). 63 Of note is the fact that the share of swaps in the total notional value of foreign exchange derivatives rose to 24 percent at the end of 2002 from 10 percent in mid-1998, which was generally attributed to a pickup in global syndicated loan and securities issuance.

Average Daily Turnover in the Over-The-Counter Derivatives Markets

(In billions of U.S. dollars)

In emerging markets, the most liquid OTC currency derivatives markets are in Singapore, Hong Kong SAR, and South Africa, where average daily turnover significantly exceeds the spot market turnover (see Table 10 ). Foreign exchange swaps and forwards are used by both foreign and domestic players for managing or gaining exposure to the exchange rate risk, with the trading volumes typically increasing during the times of large exchange rate movements. The buoyancy of these markets tends to be affected by the stringency of local currency regulation and by the degree of foreign investor participation. In Singapore, a notable pickup in crosscurrency swaps activity occurred after 1998, when the government allowed foreign entities to issue Singapore dollar bonds and to swap the proceeds into foreign currency for use outside the country. Furthermore, in 2002, the government removed the restriction that did not allow foreigners to engage in cross currency swap transactions unless there was an underlying economic activity. In Korea, up until 1999, the development of the onshore currency derivatives market was constrained by a legal requirement that any forward transaction had to be certified as a hedge against future current account flow (the so-called “real demand principle”) and therefore, most of the won/dollar forward trades look place offshore. In South Africa, the turnover in foreign exchange swaps caught up with the spot market turnover around the time of the Asian crisis and significantly surpassed the latter in subsequent years (see Figure 15 ). However, the swaps market liquidity has deteriorated notably since late 2001, when the central bank stepped up the enforcement of currency regulation requiring market participants to provide evidence of an underlying trade flow for every forward or swap transaction, and, as a result, many foreigners pulled out of the South African foreign exchange market (see Figure 16 ). 64

Average Daily Turnover in the South African Foreign-Exchange Market by Type of Transaction

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Average Daily Turnover in the South African Foreign-Exchange Swap Market

By contrast with Singapore, Hong Kong SAR, and South Africa, a significant share of currency derivatives trading in Brazil takes place at the organized exchange—Bolsa de Mercadorias & Futuros of Sao Paulo (BM&F). Besides certain features of the country’s legal framework that had hampered the development of the OTC market, the BM&F itself was actively trying to absorb part of the OTC business (see Box 7 ). 65 The expansion of currency derivatives in Brazil was stimulated by the flotation of the real in early 1999 and regulatory authorization for OTC derivatives on foreign exchange, interest rates, and price indexes. The change in the exchange rate regime coincided with sharply higher volatility in both the real/dollar rate and Brazilian interest rates, contributing to the creation of a “hedge culture.” Most of the derivatives contracts are “nondeliverable” because historically, the BM&F did not want local derivatives markets to be limited either by less than free convertibility of the real or by the size of the spot market, with the latter also being susceptible to short squeezes. In contrast to the rapid growth of derivatives markets in Brazil, the development of exchange-traded derivatives in Mexico has been slower, primarily because the exchanges in Chicago (which are in the same time zone) have launched numerous derivative products based on Mexican underlying assets.

The “nondeliverable” forward (NDF) contracts tend to be the principal instruments in the offshore derivatives markets for many emerging market currencies and are often preferred by foreign investors who have restricted access to onshore markets and want to either avoid potential costs of delivering local currencies or reduce their counterparty credit risk exposure. In most cases, NDF markets trade at a premium to local markets because offshore financial institutions have limited access to local funding. In Taiwan Province of China, for example, the average implied one-year NDF yields were around 150 basis points higher than onshore rates during 2001–02. In Korea, the existence of the “real demand principle” spurred the development of a liquid offshore NDF market in the Korean won. However, after this restriction was lifted in 1999, a lot of activity moved onshore, leading to the convergence of the offshore and onshore prices. In some cases, however, offshore markets continue to perform functions that are not performed by onshore markets. For example, while both onshore and offshore forward markets in Korea are most liquid in maturities of up to one year, the NDFs and swaps can be structured in tenors of up to 10 years in the off-shore market.

The Bolsa de Mercadorias & Futuros of Sao Paulo

The Bolsa de Mercadorias & Futuros (BM&F) of Sao Paulo, Brazil, which started operations in January 1986, ranks among the largest exchange-traded derivatives markets in the world in terms of the number of contracts transacted annually. In 2001, almost 98 million contracts were traded with a total open interest of 74 million contracts. These figures were surpassed in 2002: by the end of 2002 the cumulative number of contracts traded was 105.8 million. According to International Financial Services, London, the BM&F ranked ninth in terms of the number of contracts traded by the end of 2001, being surpassed among emerging markets only by the Korean Stock Exchange.

Trading at the BM&F takes place through the auction market system, which comprises both the exchange floor and the electronic trading system. Most contracts are traded in the auction market system, which accounted for 94 percent of all contracts traded and 97 percent of financial volume in 2001, while the over-the-counter (OTC) system accounted for the remaining transactions. The performance of all contracts traded through the auction system is guaranteed by the BM&F Derivatives Clearinghouse, which uses a safeguard structure based on intraday risk limits, market concentration limits, and collateral requirements imposed on clearing members, brokerage houses, and customers. The safeguard structure is complemented with three clearinghouse funds that provide additional levels of protection against counterparty risk. Other transactions in the OTC market system must be registered either with the BM&F or the Central of Custody and Financial Settlement (CETIP) if at least one of the counterparties is a financial institution. The settlement of OTC contracts registered with the BM&F can be guaranteed by the exchange upon request of the contractual parties provided the contract is written according to the BM&F specifications, which ensures a certain level of standardization. In practice, most of the OTC contracts are guaranteed by the BM&F.

The BM&F offers end users of the exchange a substantial number of contracts, allowing them to hedge risks or acquire market exposure. Futures contracts are available on a number of commodities, including gold, on the Sao Paulo Exchange Stock Index (Ibovespa); on foreign currencies, including the U.S. dollar and the euro; and on interest rates, including short and long interbank deposit rates, and the local U.S. dollar interest rate (Cupom Cambial). Option contracts are available on gold, interbank deposit rates, the Ibovespa, and the U.S. dollar. However, liquidity in the BM&F is heavily concentrated in a few contracts, including the one-day interbank deposit futures contracts or DI Futures, U.S. Dollar Futures, especially for those with maturities of one year or less, Ibovespa Index Futures, and Cupom Cambial futures. Some of these contracts are described next.

DI Futures . This contract allows end users to hedge or take positions on local interest rate risk. The contract size is 1 million reals and the underlying asset is the capitalized daily interbank deposit rate, as measured by the Certificate of Deposit rate, verified on the period between the trading day and the business day preceding the expiration date of the contract, which is the first business day of the contract month. All contracts are settled on a cash basis. Contracts months include the first four months subsequent to the month during which a trade is made, and months that initiate a quarter (January, April, July, and October). DI Futures with maturities less than two years enjoy good liquidity, with an average daily turnover in the range of $5 billion to $10 billion.

Foreign exchange derivatives . The two- and three-month U.S. Dollar Futures, with contract sizes of $50,000, are the most traded and liquid contracts, with an average daily trading volume of around $3 billion. Contract months include every month of the year and should be settled on a cash basis the next business day following the last business day of the previous month. Hedging and speculation in the foreign exchange market can also be accomplished via U.S. Dollar European and American Options in the auction and OTC market systems, respectively. The average daily trading volume in this market is only around $250 million, a fraction of the volume traded in the futures market. In terms of open interest, though, U.S. Dollar Options accounted for 30 percent of total exchange-traded foreign currency instruments by the end of July 2002.

Ibovespa Index Futures , Local investors can engage in index arbitrage and hedge positions on the main Brazilian stock market index, Ibovespa, through Ibovespa Index Futures. The contract size in Brazilian reals is equal to three times the level of the index. These contracts mature every two months and are settled on a cash basis on the next business day following the Wednesday closest to the 15th calendar day, which is the last trading day. Trading in the Ibovespa index futures comprises 86 percent of total trading in stock index instruments, as measured by number of traded contracts.

Cupom Cambial Futures . The Cupom Cambial for a given maturity is the spread basis points higher than onshore rates during 2001–02. In Korea, the existence of the “real demand principle” spurred the development of a liquid offshore NDF market in the Korean won. However, after this restriction was lifted in 1999, a lot of activity moved onshore, leading to the convergence of the offshore and onshore prices. In some cases, however, offshore markets continue to perform functions that are not performed by onshore markets. For example, while both onshore and offshore forward markets in Korea are most liquid in maturities of up to one year, the NDFs and swaps can be structured between the local interest rate, as measured by the interest rate on interbank deposits, and the exchange rate variation during the life of the contract. From this definition, it is clear that the Cupom Cambial is equivalent to the onshore U.S. dollar interest rate and, hence, its level is affected by corporate demand for foreign currency hedging. The Cupom Cambial Futures allow local market participants—mostly nonfinancial companies, banks, and mutual funds—to position themselves in the local U.S. dollar interest rate market. Contract size is $50,000 and contract months and expiration dates are established by the BM&F. Contracts are settled in cash.

The BM&F follows state-of-the-art risk management procedures to deal with market risk, liquidity risk, and counterparty risk. These procedures have helped the BM&F to withstand several episodes of market turbulence, including the January 1999 crisis, the Argentina crisis by the end of 2001, and the current volatility associated to the recent presidential elections. Despite this impressive track record, the BM&F remains highly exposed to sovereign risk, as close to 90 percent of the exchange’s collateral is comprised by Federal Government Bonds.

Compared with other emerging markets, the liquidity in the Central European onshore derivatives markets remains limited due to the lack of effective infrastructure and also to some extent existing regulatory constraints on the use of hedging instruments by local corporates and pension funds. Hungary has seen a strong pickup in currency derivatives trading since the move to greater exchange rate flexibility and removal of capital controls; but, compared with Poland, liquidity is still low (see Tables 9 and 10 ). Many of the derivatives linked to the Central European currencies are reportedly traded offshore, mainly out of London. More recently, both Poland and Hungary have made significant progress in improving legal and documentation infrastructure for derivatives trading. The Polish government adopted new provisions on netting and credit support, while in Hungary, the close-out netting provisions came into effect in January 2002. Legal certainty regarding enforceability of close-out netting reduces credit risk arising from OTC derivatives transactions by allowing market participants to calculate their net obligation vis-à-vis an insolvent party.

• Fixed-Income Derivatives

In contrast to recent trends in global currency derivatives market, the global fixed-income derivatives market continued to expand steadily over the past few years, with interest rate swaps (IRS) being the largest and the fastest growing market segment. From end-1998 to end-2002, the notional value of all outstanding interest rate contracts in the global OTC market doubled, reaching $102 trillion (see BIS, 2002b ). The rapid expansion of the IRS activity was triggered by the liquidity crunch in the spot and exchange-traded derivatives markets during the Russia/LTCM crisis and the reduction in the U.S. government bond market liquidity due to the planned debt repayments. These were generally seen as the main factors that forced market participants to look for alternative hedging and benchmark instruments and encouraged the shift into the OTC swap market (see IMF, 2001 ). Following the collapse of the telecommunications, media, and technology (TMT) bubble, an increased equity price volatility and a continued decline in interest rates forced many investors, including those in emerging markets, to shift from stocks to bonds, turning to the bond futures and IRS markets either in search of yield or to hedge their bond exposures. The structure of the global fixed-income derivatives market is similar to that of currency derivatives—that is, the OTC segment is significantly larger (when measured in terms of notional values) than the exchange segment, although the average daily turnover in the latter is higher, possibly due to shorter maturity of the exchange-traded instruments.

In emerging market countries, the most liquid fixed-income derivatives markets are in Singapore, Hong Kong SAR, Brazil, Mexico, and South Africa (see Tables 9 - 11 ). In Latin America and Singapore, most of the fixed-income derivatives trading takes place at the organized exchanges, but in Korea and South Africa it is mainly concentrated in the OTC market (see Table 9 ). Those markets that were deregulated more extensively (most notably in Korea) experienced the fastest growth. In terms of notional values, the Singapore Exchange (SGX) is still far ahead of other emerging markets, with most traded fixed-income derivative contracts including Euroyen LIBOR, Euroyen TIBOR, and Eurodollar futures and options. The rapid pickup in the fixed-income derivatives activity in Mexico was due to an increased government bond issuance, easier access to derivatives trading for local banks and brokers (because of a relaxation of certain administrative restrictions), and the introduction of new products by the Mexican Derivatives Exchange (MexDer) (see Figure 17 ). In contrast to Mexico, the fixed-income derivatives activity in Brazil has contracted, largely reflecting the weakness of the underlying bond market.

Exchange-Traded Options and Futures Contract Trading Volume, 2002

Mexican Bond Issuance and Interest Rate Futures

Falling interest rates and increased local bond issuance were the main factors that spurred the expansion of the local currency IRS markets. In addition, the proliferation of structured products in Hong Kong SAR, Korea, and, more recently, Taiwan Province of China created additional demand for instruments, such as interest rate swaps, which are used to hedge these exposures. In some countries, most notably in Brazil and Hong Kong SAR, the IRS market has become more liquid than the underlying cash market and as a result performs functions that are typically provided by bond markets, such as price discovery and provision of benchmarks. For example, in Brazil, the local swap curve is the benchmark yield curve for maturities beyond one year. In Hong Kong SAR, given the relatively small size of Exchange Fund bond issues, the swap market is more liquid and therefore drives the pricing of local bonds. By contrast, the South African government bond yield curve remains the benchmark curve, despite the fact that the outstanding notional value of local currency interest rate swaps significantly exceeds the local bond market capitalization. This is largely due to the fact that the South African government’s debt management policy was specifically aimed at maintaining and improving the liquidity of the benchmark bond issues.

In some countries, the presence of sophisticated institutional investors and the relaxation of restrictions on their participation in local derivatives markets contributed to the rapid expansion of the fixed-income derivatives activity. For instance, one of the key drivers behind the growth of the IRS market in Korea was the entry of the investment trust companies that were allowed to hedge up to 5 percent of total assets using local derivatives. In Singapore, insurance companies, which form the core of the local institutional investor base, increased their participation in the longer-dated interest rate derivatives market as well. Similarly, in Taiwan Province of China, pension and insurance companies became more active users of debt-related derivatives, following their shift toward fixed-income investments and away from equity and real estate. In South Africa, unit trusts are less involved in the swap market because of a number of restrictions. However, other institutional investors are very active in the IRS market, with local banks concentrating on the one- to five-year maturity segment and pension funds—on the 5+ year spectrum. In Mexico, the regulatory authorities have recently issued guidelines for pension funds limiting their use of derivative products only by a certain level of the Value-at-Risk measure. Because in many countries regulation allows local institutional investors to use only standardized exchange-traded products, the introduction or, in some cases, widening of the range of such instruments may be a necessary condition for further expansion of the derivatives activity. 66

In contrast to the IRS markets, the government bond futures markets in emerging economies tend to be less active. Since bond futures are primarily used for hedging the underlying bond exposures, the liquidity in bond futures is very sensitive to the spot market activity. For instance, the average trading volume of the three-year Korean government bond future contract has closely mirrored the performance of the underlying bond since the introduction of the derivative contract in September 1999 (see Figure 18 ). Thus, countries with less developed government bond markets are generally less successful in developing bond futures markets, especially when there are alternative hedging instruments that are sufficiently liquid. One example is the future contract on the five-year Singapore government bond, which was launched in June 2001 but never look off in earnest, with the average daily volume falling from 878 contracts in July 2001 to only about 10 contracts at the end of 2002. This was partly due to the weak activity in the underlying instrument, but also to the fact that local banks, which were the main holders of government bonds, could hedge their bond positions more efficiently by using swaps. South Africa is another interesting case, where the bond market is very liquid and there are several benchmark bond futures listed on the exchange; however, most of them are rarely traded. The illiquidity of bond futures in South Africa is explained by the existence of a very liquid domestic bond repo market (the so-called “carry market”).

Korean Government Bond Futures

• Equity Derivatives

Compared to currency and fixed-income derivatives, the equity-based derivative products represent a much smaller part of the global market, with the bulk of activity concentrated at the organized exchanges. This reflects in part the diminishing role of local equity markets as a source of funding for local entities. Nonetheless, the volume of exchange-traded equity futures and options in most major markets rose steadily over the past few years, as the increased volatility in global equity markets, as well as the introduction of retail-oriented and sector-based products, led more market participants to use equity derivatives.

While most exchanges in emerging Asia experienced steady expansion in equity derivative products over recent years, the stock index derivatives’ growth in Korea was spectacular (see Figure 19 ). The average daily trading volume in KOSPI 200 options and futures, which are the most liquid derivative contracts traded on the Korean Stock Exchange (KSE), rose to 4.7 million contracts at the end of 2002 from 0.9 million contracts at the end of 2000. 67 As a result, Korea now accounts for about 30 percent of global turnover in stock index derivatives. 68 The average daily volume of index futures and options traded on Taiwan Futures Exchange (Taifex) doubled between the end of 2000 and the end of 2002. Outside Asia, South Africa has the most developed equity derivatives market in the emerging markets universe. In fact, the outstanding notional of equity derivative products traded on the Johannesburg Stock Exchange (JSE) and the South African Futures Exchange (SAFEX) exceeded that of the KSE in mid-2001 (see Table 9 ). However, the derivatives trading volumes on JSE/SAFEX declined during the past few years, reflecting the trends in the underlying equity market, the ongoing consolidation in the banking sector and asset management industry, and the retrenchment of some foreign liquidity providers. In Latin America, the average daily trading volume of stock index derivatives at the Brazilian Bovespa is the highest in the region and is roughly similar to that of South Africa and most markets in emerging Asia (excluding Korea).

Average Daily Trading Volumes in Equity Index Derivatives in Asia

(In thousands of contracts)

The individual stock options traded in emerging markets are typically significantly less liquid than benchmark index futures and options. Although the cross-country comparisons of the outstanding notional values of single equity derivatives in emerging markets are hampered by data availability, based on the number of contracts traded, Bovespa appears to be by far the most active market for single equity derivatives in the emerging markets universe (see Table 11 ). In South Africa, single stock options exist for about 40 corporate names, but are significantly less liquid than index options. These instruments are typically launched in the OTC market and subsequently listed on the exchange.

Local equity derivatives in emerging markets are used by a wide range of market participants. Local corporates are the main users of single stock options. Asset managers, who are typically bench-marked against various indices, are the main users of stock index futures and options, while pension funds often prefer equity-linked notes. Market data for Korea indicates that domestic individual investors tend to be the most active users of stock index futures traded on local exchanges (see Figure 20 ). Similarly, around 90 percent of the futures market in Taiwan is reportedly represented by retail investors. In South Africa, both residents and nonresidents participate in the market, with foreigners at times accounting for half of the trading volume. However, in contrast with Asian markets, the retail investor base for equity derivatives in South Africa is fairly small.

KOSPI 200 Index Futures: Cumulative Net Purchases

(In millions of U.S. dollars)

Over the past two years, many derivatives exchanges around the world took measures to increase individual investor participation. Both the Hong Kong Exchanges and Clearing (HKE) and the Taiwan Futures Exchange (Taifex) introduced new products targeting individual investors, such as small-sized equity index futures and also the so-called equity-linked principal protected products. 69 According to market sources, the equity-linked principal protected products market in Hong Kong SAR reached more than $1.5 billion in late 2002. Similar instruments are expected to rapidly gain popularity in Korea, where the retail investor base is larger than in Hong Kong SAR. However, more recently, some KSE officials began to voice concerns over excessively high individual investor participation in the futures market, saying that retail investors could exacerbate volatility by following the investment patterns of the better-informed foreign institutional investors. Outside Asia, many emerging market exchanges took steps to increase individual investor participation as well. For example, the Brazilian Bovespa launched the small-sized equity index contracts in September 2001.

• Credit Derivatives

Although the credit derivatives market is still a small part of the global derivatives market, it remains one of the fastest-growing segments notwithstanding several major credit events that occurred during the past few years (Russia, Argentina, and Enron). The data collected as part of the BIS Triennial Survey showed that positions in the global credit derivatives market rose to $693 billion at the end of June 2001 from $118 billion at the end of June 1998. Separately, according to the British Bankers’ Association (BBA) Credit Derivatives Report 2001/2002 (see Deutsche Bank, 2003 ), the total notional value of all credit derivatives products referencing both mature and emerging market names stood at $1,189 billion as of end-2001.

The emerging credit derivatives market mainly consists of credit protection instruments on external sovereign bonds that are traded offshore. The estimates of the size of this market range from $40 billion for the outstanding notional as of mid-2001, according to a Risk survey , to $300 billion suggested by Deutsche Bank. 70 Nonetheless, this means that the share of emerging market instruments in the global credit derivatives market is much larger than their share in other global derivatives markets. The most commonly used credit derivatives in emerging markets are credit default swaps (CDSs), credit-linked notes (CLNs), and collateralized debt obligations (CDOs). 71 The sovereign CDSs are the most liquid instruments in the emerging credit derivatives market, accounting for around 85 percent of the total outstanding notional. The most actively traded contracts reference the external sovereign bonds issued by Korea, Mexico, Brazil, Russia, and Singapore. 72 A relatively few top-tier corporate credits (in Latin America, these include mainly Mexican names, such as Telmex and Cemex) are also traded in the CDS market, but these instruments are considerably less liquid and reportedly account For less than 5 percent of the emerging CDS market /ex-Asia. Compared with other regions, the CDS activity in emerging Asia has been limited by the relatively small size of the external sovereign bond market. However, the CDSs are rapidly gaining popularity, as they often provide higher market liquidity, higher returns, and longer yield curves than the U.S. dollar-denominated sovereign bonds. According to market sources, the average daily trading volume in the Asian CDS market rose to $200 million in 2002 from $100–150 million in 2001. Also, several investment banks have recently launched credit derivative index (CDI) products that allow investors to gain exposure to portfolios of credit-default swaps referencing sovereign or corporate names in emerging markets. 73

Market participants use credit default swaps for hedging against (or gaining exposure to) changes in credit spreads and default risk. Compared with bonds, the CDSs have several advantages: (1) credit default swaps allow positions in maturities for which the cash instruments are illiquid or unavailable; (2) there is typically no collateral or up-front cash payment; and (3) the credit default swaps provide investors with an opportunity to take a short position vis-à-vis a particular credit for a longer term than in the repo market, in which positions typically have to be rolled over every one-to-three months. 74 In fact, emerging market credit default swaps are often used to take exposure to sovereigns for maturities shorter than those corresponding to outstanding bonds and to express views on sovereign (default risk and on cross-country relative values (see Box 8 ).

Some emerging markets over the past few years experienced a pickup in local credit derivatives activity. In Brazil, the government has made the first steps toward developing the onshore credit derivatives markets by allowing local banks to trade credit risk. Also, the Brazilian Central Bank issued a circular outlining the accounting procedures for credit derivatives in 2001, and the Brazilian payment and settlement system for OTC markets (CETIP) launched a registration system for credit default swaps in early 2004. In Korea, there has been a notable pickup in local currency credit-linked notes referencing Korean corporate, sovereign, and quasi-sovereign credits. According to the Bank of Korea, the volume of CLNs rose to $1.2 billion in 2002 from $0.7 billion in 2001. The main attractions of CLNs for Korean investors are higher yield and longer duration compared with those offered by government and corporate bonds. In South Africa, credit derivatives activity picked up in 2000–01 amid low interest rates on government bonds, but stalled after the central bank hiked the rates. According to market sources, the credit default swaps of up to one-year maturity currently exist for only a few South African corporates. In general, the expansion of credit derivatives in emerging markets is constrained by the relatively small size and illiquidity of the local corporate bond markets as well as by the lack of standardized documentation and regulatory uncertainties regarding the treatment of credit derivatives for accounting and tax purposes. 75 Nevertheless, local banks manage to get around these problems by offering CLNs, which reference corporate bonds and promissory notes that are unlisted but traded over-the-counter. Going forward, many market analysts foresee the local credit derivatives market providing price discovery for the spot market and, thus, encouraging securitization.

Credit Default Swap Spreads in Emerging Markets

The credit default swap curve, a plot of credit default swap spreads for different maturities, conveys useful information about market views on a sovereign’s ability to honor its external debt, as well as the recovery value bond investors can obtain in case of debt default. The credit default swap curve is normally upward sloping because credit deterioration is more likely in the medium and long term than in the short term. If the sovereign is able to meet its debt repayments in the short term, changes in market perception about debt sustainability would likely result into parallel or steepening movements of the credit default swap curve. In contrast, problems associated to short-term financing needs would lead to a flattening of the credit default swap curve, as short-term spreads widen to compensate protection sellers for the increase in short-term risk. During periods of market stress, the credit default swap curve can become inverted, as in the case of Argentina during the second half of 2001, and more recently, of Brazil since June 2002.

Further information on default probabilities for a sovereign for different time horizons can be extracted using standard credit default swap valuation models. The Figure shows the evolution of one-year and two-year default probabilities for Argentina between January 1990 and December 2001. 1 The approval of an IMF package for Argentina at the end of 2000 contributed to soothe investors’ sentiment and reversed a sharp spike in default probabilities experienced in November 2000. However, increased concerns about the ability of Argentina to meet its debt payments amid continued deterioration of the country’s fiscal position, together with an uncertain political climate, caused default probabilities to creep upwards during 2001. By the end of the second half of 2001, default probabilities reached levels not observed ever before. As it became clear that no further external aid was forthcoming and that the government would refrain from implementing significant fiscal measures, default probabilities increased significantly at the end of the third quarter of 2001. By mid-December 2001, trading on Argentina default swaps stopped completely as no participant was willing to take a long position on Argentina credit risk, a position validated by Argentina’s default in January 2002.

Sovereign Credit Default Probability and EMBI+ Spread for Argentina

Credit default swaps are not the only financial instruments that contain useful information about sovereign risk, as sovereign bond spreads are also useful indicators of sovereign debt solvency. Indeed, the Figure shows the high correlation between the default probabilities implied by credit default swaps and the EMBI+ spread for Argentina. 2 However, liquidity in the cash market is more likely to dry out during periods of stress than in the credit default swap markets. In fact, there is anecdotal evidence that following the serious disruptions in the cash market clearing mechanisms in the aftermath of the events of September 11, 2001, price discovery migrated from the cash market to the credit derivatives market.

Local Derivatives Markets and Capital Flows to Emerging Economies

There is a broad consensus that the rapid expansion of derivatives products during the past 10 to 15 years was one of the key factors that facilitated the rise of global cross-border capital flows (see, for example, Garber, 1998 ; and Dodd, 2001 ). Various traditional cross-border investment vehicles, such as loans, bonds, equities, and FDI, can potentially expose both lenders and borrowers to foreign exchange risk, interest rate, market, credit, and refinancing (liquidity) risks. By allowing market participants to unbundle and redistribute these risks to those who are in a better position to manage them, derivatives make cross-border investments more attractive, thereby increasing net flows and creating more opportunities for portfolio diversification. There are many ways in which the use of derivatives by local and foreign market participants can facilitate cross-border capital flows. Here are a few examples.

Currency derivatives can be used to change the currency of denomination of asset holdings and, therefore, to hedge investments against unexpected changes in exchange rates by both foreign and local investors. Foreign investors typically use currency derivatives to hedge their long local currency exposure in emerging markets, while local entities often use the same instruments to manage foreign exchange risk associated with external financing, typically in G-3 currencies. Thus, the level of external fund-raising by local entities is directly related to the availability of the currency hedging instruments.

Another example is the basic single-currency interest-rate swap, which can allow the borrower with a floating interest rate loan/bond to hedge the interest rate risk by swapping floating rate payments for fixed-rate payments. Because interest rate swaps give borrowers an opportunity to exploit their comparative advantages for borrowing at fixed versus floating rates in different markets, they may encourage corporates or banks to seek external financing at more favorable terms instead of borrowing locally. Thus, the use of single-currency swaps can generate gross cross-border flows. In some emerging markets, most notably in Brazil, where the local corporate treasurers’ benchmark is a floating local currency interest rate, whereas funds raised internationally are typically at a fixed U.S. dollar rate, interest rate swaps have become central to the ability of local entities to manage the risks associated with foreign borrowing.

Finally, credit derivatives represent another class of instruments that can potentially increase net flows into emerging markets. An attractive feature of credit derivatives is that they allow investors/lenders to manage the default/bankruptcy risks without having to buy or sell the underlying securities. For example, a foreign bank can reduce its credit exposure to a particular client without physically removing assets from its balance sheet and thus effectively separate relationship management from risk management Some market analysts argue that if international banks could use onshore credit derivatives in emerging markets, they would be more willing to maintain or increase their exposure to local corporate clients.

• Local Participation

Local entities with foreign exchange exposures are typically among the most active users of derivatives in emerging markets. Given that domestic Financial markets in many emerging economies are not deep enough for large local corporates to borrow long term and in large size, domestic companies often have to rely on international bond or syndicated loan markets for this type of funding. Thus, when the local corporate sector has a positive net external financing requirement, the development of the onshore derivatives markets becomes a critical factor in facilitating external fund-raising. Of course, in the case when emerging market companies with the internationally diversified production (for example, the South African mining companies) limit their foreign currency borrowing strictly to financing those operations that earn income in the same currency, there may not be much need for foreign currency hedging. However, this financing decision may not necessarily be optimal, given the relative costs of funds (domestic versus external), and may be due to either the unavailability or the high cost of hedging instruments. The latter should be improving as the emerging derivatives markets become more mature.

The relative importance of derivatives for local entities’ fund-raising in international markets varies across emerging economies. In Emerging Europe and Asia, this link is not as strong as in Latin America. Following the Asian crisis, many countries in emerging Asia shifted toward relying more on local currency financing. In addition, many of these countries are running current account surpluses and thus do not have positive net external financing requirements. In emerging Europe, local entities are still constrained by regulatory restrictions on the use of derivatives. By contrast, in Brazil, the link between fund-raising in international markets and derivatives activity has been particularly strong (see Figure 21 ). Virtually all local companies that have access to international financial markets raise U.S. dollar-denominated funds and then turn to the local derivatives market to swap the external financing obligations into reals with an interest rate indexed to the overnight (GDI) rate. Historically, the cost of U.S. dollar hedges in Brazil was fairly high due to the shortage of hedging instruments, as most domestic institutional investors did not have foreign currency positions (in contrast to the Chilean pension funds) and many exporters with the U.S. dollar receivables typically had overall net short U.S. dollar positions. As a result, Brazilian corporates tended to invest part of their cash reserves in U.S. dollar-denominated securities in order to provide at least partial protection against an adverse exchange rate move. In 1999, the Brazilian Central Bank (BCB) stepped in as the main provider of currency hedge to the market through the issuance of U.S. dollar linked securities. Furthermore, in March 2002, the BCB decided to split the exchange rate linked instruments into real -denominated bonds and foreign exchange swaps in order to lower its debt rollover costs and also to reduce the cost of currency hedging for local entities. 76

International Bond and Loan Issuance and Derivatives Trading Volume in Brazil

The development of the domestic credit derivatives markets in emerging economies can facilitate a more accurate pricing of corporate credit risk and help to attract foreign capital flows going forward. Many analysts believe that since local market participants are more familiar with local credit risk and less concerned about market liquidity than foreign investors, they are “natural” sellers of credit protection on emerging market corporate risk. At the same time, the domestic financial institutions that already have exposure to local corporate credit risk (in the form of bonds, loans, and receivables) are in a better position to structure products that match local investors’ preferences for credit risk than foreign banks. Thus, local market participants can play a key role in the development of the domestic market for corporate credit risk protection. Of note is the fact that local institutional investors, particularly pension funds and insurance companies, have been gradually increasing their use of CLNs and structured products.

• Foreign Participation

Foreign investors in emerging markets generally include banks, corporates, “real money” accounts (both dedicated and cross-over investment funds), and speculative money accounts (hedge funds and proprietary trading desks of investment and commercial banks). Compared with local entities, the foreign investors’ participation in the emerging derivatives markets is fairly limited. Mexico, Hungary, Poland, and the Czech Republic have seen a considerable demand by international investors for long-term interest rate and local currency exposures that was driven in part by the so-called “convergence trades,” with exposures established in both cash and derivatives markets. 77 As far as the OTC markets are concerned, the extent of foreign investor participation (both as final users of the derivative products as well as intermediaries) varies. In some countries, such as Singapore, Hong Kong SAR, and South Africa, foreign dealers account for the bulk of the turnover in the OTC markets, while in other countries, most of the trading goes through domestic dealers.

Both anecdotal evidence and industry surveys suggest that “real money” funds hedge relatively little of their risk exposures in emerging markets, either because of internal restrictions on leveraged positions or because these risk exposures are desirable. A survey of derivatives usage by U.S. institutional investors conducted by the NYC Stern School of Business in 1998 ( Hayt and Levich, 1999 ) showed that only 46 percent of respondents were permitted to use derivatives by their investment mandate, and only 27 percent of respondents had open derivatives positions at the time of the survey. Because many emerging market countries maintain various restrictions on foreign participation in local derivatives markets, one would expect that the percentage of the emerging market funds using local derivatives to hedge various risk exposures is even lower.

Even when there are no restrictions on foreign participation in emerging derivatives markets, foreign investors (equity investors, in particular) often prefer to take outright foreign currency exposure. Thus, one would not expect to find a strong link between foreign inflows and derivatives activity even in those emerging markets, where foreign participation is significant. Indeed, our analysis of foreign institutional investors’ purchases of stocks in Brazil, Korea, Taiwan Province of China, and South Africa and the trading volumes in the onshore currency and equity derivatives markets suggests that there is no statistically significant relationship between foreign purchases of shares and derivatives’ trading volumes in these countries. 78 It should be noted that in some emerging markets, local equities are a “natural hedge” against the foreign exchange risk (for example, in South Africa, the share prices of mining companies with dollar receivables are often referred to as “rand hedges”). Unlike equity investors, bond investors sometimes do hedge their long local-currency bond exposures in emerging markets. Also, in those emerging markets where bond repo markets are sufficiently liquid, foreign investors often prefer to repo bonds instead of purchasing bonds outright and simultaneously hedging the foreign exchange risk with derivatives.

In contrast with the “real money” accounts, speculative investors can use derivatives freely for hedging risks associated with their cash market positions or for gaining leveraged returns or for exploiting relative value opportunities between the cash and derivatives markets. However, according to Credit Suisse First Boston/Tremont, the leading provider of the hedge fund indices, the hedge funds that invest in emerging markets often employ a long-only strategy because “many emerging markets do not allow short selling, nor offer viable futures or other derivative products with which to hedge.” 79 In contrast to many other emerging markets, foreigners were the dominant players in the South African foreign exchange and interest rate swap markets until late 2001 (see Figure 16 ), using derivatives either to bet on their currency and interest rate views or to proxy-hedge the emerging market risk (with the latter due to the rand being one of the most liquid currencies in the emerging markets universe).

Both leveraged investors and dedicated emerging market debt funds are active participants in the credit derivatives markets for emerging market U.S. dollar-denominated bonds. The main protection sellers in credit derivatives markets are the major internationally active banks. Hedge funds have been active users of emerging market credit derivatives, mainly focusing on trading the basis between default swaps and bonds amid increased volatility in emerging debt markets. 80 The “convertible arbitrage” funds have also been among the active buyers of credit protection, using credit default swaps to strip the credit component from the equity option of convertible bonds. The main features of credit derivatives that make them particularly attractive for hedge funds are: they provide an efficient way to short a credit with a relatively low risk of a short squeeze, and they are better instruments for structuring any relative value trading strategies than bonds because they allow better alignment between maturities of different credit exposures. However, for “real money” accounts, CLNs represent a more viable investment alternative than CDSs, since these funds are typically allowed to invest only in cash instruments. 81 Since the ability of foreign investors to manage the emerging market corporate default risk remains limited due to the relatively underdeveloped state of the corporate credit default markets), many emerging market borrowers are forced to issue bonds with various credit enhancements, particularly when the perceived credit risk is high (see Chapter V of IMF, 2002a ).

The Role of Derivatives in Emerging Market Crises

While derivatives do play a positive role by reallocating risks and facilitating growth of capital flows to emerging markets, they can also allow market participants to take on excessive leverage, avoid prudential regulations, and manipulate accounting rules when financial supervision and internal risk management systems are weak or inadequate. In particular, the use (or rather misuse) of derivatives can potentially allow financial institutions to move certain exposures off balance sheets, thereby magnifying their balance sheet mismatches in ways that may not be easily detected by prudential supervisors and, as a result, may lead to a gradual buildup of financial system fragilities. Also, due to their very nature (i.e., the fact that they allow market participants to establish leveraged positions), derivative instruments tend to amplify volatility in asset markets. Thus, a negative shock to a country with already weak economic fundamentals, which typically triggers a sell-off in local asset markets, can also lead to an unpredictable and rapid unwinding of derivatives positions that can in turn accelerate capital outflows and deepen the crisis.

This section will discuss the role of derivatives in several emerging market crises focusing mainly on two issues: the types or financial derivatives used by market participants before the onset of a crisis and how the use of these instruments affected the stability of the domestic financial system; and the impact of the unwinding of derivatives positions on the crisis dynamics after the onset of a crisis. While the Mexican and Asian crises highlighted the role of structured notes and swaps in magnifying balance sheet mismatches and the associated volatility in foreign exchange markets, the Russian and Argentine crises demonstrated the importance of counterparty risk and spillovers through credit markets. It should be pointed out that deteriorating fundamentals—mostly fiscal, but also financial in the case of Asia—were the main causes of the recent emerging market crises, but derivatives amplified the impact of these crises on financial systems of emerging market economies. It should also be noted that the analysis of the role of derivatives in emerging market crisis is seriously hampered by data availability, since the OTC derivatives transactions are not reported systematically. Thus, in many cases, anecdotal evidence and reported (ex post) losses on derivatives positions by major investment banks of the industrial countries are the main sources of information.

• The Mexican Crisis, 1994

In the early 1990s, the recently privatized Mexican banks engaged in an aggressive building up of their on- and off-balance sheet positions, which led to an increase of their credit and market risk exposures well beyond prudential limits. In particular, they used various derivatives to achieve leveraged returns. One of the popular instruments that allowed local banks to leverage their holdings of the exchange rate linked treasury bills (the Tesobonos) was a tesobono swap ( Garber, 1998 ). In a tesobono swap, a Mexican bank received the tesobono yield and paid U.S. dollar LIBOR plus X basis points to an offshore counterparty, which in turn hedged its swap position by purchasing tesobonos in the spot market. The only transactions that were recorded in the balance of payments were; an outflow of bank deposits related to the payment of collateral by the Mexican bank, and a U.S. dollar inflow related to the purchase of tesobonos by the foreign investor. Thus, traditional balance of payments accounting provided a misguided representation of capital flows and associated risks—that is, although it appeared that the foreign investor had a long position in government bonds, it was in fact the local bank that bore the tesobono risk, while the foreign investor was effectively providing a short-term dollar loan. Tesobono swaps were not the only instruments that allowed local banks to establish leveraged positions financed by short-term U.S. dollar loans from their offshore counterparties; other instruments included various structured notes and equity swaps. 82

At the onset of the crisis and in the face of rising political uncertainty and weakening fundamentals that ultimately forced the authorities to float the peso, the tesobono yields jumped from 8 percent to 24 percent. As a result, the U.S. dollar value of the collateral fell, triggering margin calls on Mexican banks. Quoting market sources, Garber (1998) suggested that the total of margin calls on tesobono and total return swaps was about $4 billion, adding to the pressure on the Mexican peso foreign exchange market. 83

• The Asian Crises, 1997–98

As in the Mexican crisis, unhedged currency and interest rate exposures were key determinants of the severity and scope of the Asian crises (see IMF, 1998a ). Banks and non-financial corporations in Asia left their exposures unhedged because (1) domestic interest rates were higher than foreign interest rates, (2) the pegged exchange rates were generally perceived as stable, and (3) domestic hedging products were underdeveloped, while offshore hedges were expensive. Because of these factors, foreign banks were eager to lend to East Asian banks that tried to capture carry profits on the interest rate differentials. However, local prudential regulations, such as restrictions on the net open foreign exchange exposures and risk-to-capital ratios, limited the amount of profitable arbitrage trade. Therefore, Asian financial institutions turned to derivatives “to avoid prudential regulations by taking their carry positions off balance sheet” ( Dodd, 2001 , p. 10).

According to market sources, the majority of losses reported by both U.S. and European banks on their Asian lending were listed as due to swap contracts, with the latter presumably including both total return swaps and currency swaps ( Kregel, 1998 ). In a total return swap, one counterparty pays the other the cash flows (both capital appreciation and interest payments computed on a mark-to-market basis) generated by some underlying asset (equity, bond, or loan) in exchange for dollar LIBOR plus X basis points. Thus, the flows between Asian financial institutions and foreign counterparties were similar to those in the tesobono swap described above. As in the case of tesobono swaps, offshore counterparties were buying the underlying assets to hedge their swap positions, while local banks were left with short U.S. dollar positions. After weakening fundamentals led to a collapse of the exchange rate peg and domestic interest rates rose, both counterparties had incentives to either unwind the swaps or hedge their foreign exchange exposures, which exacerbated the sell-off in Asian assets and currencies. 84

• Russia’s Default and Devaluation, 1998

Although the poor state of Russia’s fiscal accounts was well known by mid-1998, the announcement of a 90-day moratorium on external debt payments on August 17, 1998 caught most market participants by surprise. At the time of the default and devaluation, the estimates of the outstanding notionals of the U.S. dollar-ruble NDF contracts ranged from $10 billion to $100 billion, and the total foreign exposure to the domestic bond market (GKO/OFZs) was around $20 billion. According to market sources, the U.S. dollar-ruble foreign exchange forwards with Russian firms as counterparties were the largest source of credit losses by major swap dealers during 1997–98, exceeding the losses made on their Asian lending. The events in Russia highlighted the presence of convertibility risk even when local currency positions in emerging markets were hedged, and raised the issue of the NDF valuation when an official rate was not available. In addition, Russia’s default sent shock waves through the credit derivatives markets, with the cost of protection increasing in all sectors, including the investment-grade segment. Ambiguous and often misleading definitions of reference obligations, credit events, and settlement mechanics made it difficult for protection buyers to enforce the contracts. According to dealers, there was initially some confusion about which event had to trigger the credit default swap contracts—the declaration of the moratorium on debt payments or the actual default on obligations. In addition, it was unclear whether the CDS contracts that did not explicitly include cross-default clauses with the already restructured Soviet-era debt obligations (PRINs and IANs) had to be triggered by a default on these bonds. In order to address the legal issues highlighted during the Russian crisis, the International Swaps and Derivatives Association (ISDA) issued new credit derivative documentation guidelines in 1999. 85

• Argentina’s Default and Devaluation, 2001

In contrast with the Russian crisis, the Argentine default and devaluation in December 2001 were widely anticipated and occurred at a time when the credit derivatives market was relatively more mature. The protracted recession and gradual deterioration of the sovereign’s credit quality gave market participants sufficient time to exit the bond and credit protection markets and also allowed the main sellers of credit protection on Argentine sovereign bonds (broker-dealers) to hedge their books in the repo market. The liquidity in the Argentine CDS market dried up in August-September 2001, following a bout of volatility in July. The announcement of the moratorium on all debt payments on December 23, 2001 was unanimously accepted as a “repudiation/moratorium” credit event consistent with the ISDA definitions. There were, reportedly, some disputes as to which bonds could be considered as “deliverable,” but they have been resolved fairly quickly. According to market sources, 95 percent of all credit default swaps were settled by mid-February 2002 and there were no reported failures to deliver, with the total notional amount of credit protection outstanding at the end of November 2001 estimated at $10–15 billion (see Deutsche Bank, 2003 ). 86

• Concluding Remarks

Local derivatives markets in emerging economies have grown rapidly over the past few years, especially in countries that have removed capital controls and have developed their underlying securities markets. The growing use of derivative products by emerging market participants has also supported capital inflows and has helped investors to price and manage the risks associated with investing in emerging markets more efficiently. However, the use of derivatives has also made crisis dynamics in some recent episodes more unpredictable by accelerating capital outflows, amplifying volatility, and, in some cases, increasing the correlation between asset and currency markets. In many of these episodes, the negative impact of derivatives on crisis dynamics was either clue to the immaturity of local derivatives markets or due to weak prudential supervision, which allowed some financial institutions to build up leveraged positions before the onset of a crisis. The policy implications of the trends described in this chapter were discussed in a broader context of the development of local securities markets in Chapter I .

Within Same Series

• CHAPTER IV OVER-THE-COUNTER DERIVATIVES MARKETS
• II Developments, Trends, and Issues in the Mature Financial Markets
• CHAPTER I LOCAL SECURITIES AND DERIVATIVES MARKETS IN EMERGING MARKETS: SELECTED POLICY ISSUES
• Annex I Major Capital Markets: Trends and Recent Developments
• CHAPTER II DEVELOPMENTS AND TRENDS IN MATURE CAPITAL MARKETS
• IV Developments and Trends in Mature Financial Markets
• II The Asian Crisis: Capital Markets Dynamics and Spillover
• CHAPTER III EMERGING MARKET FINANCING
• II Developments and Trends in the Mature Markets
• III Emerging Markets: The Contraction in External Financing and Its Impact on Financial Systems

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• CHAPTER IV SELECTED TOPIC: THE ROLE OF FINANCIAL DERIVATIVES IN EMERGING MARKETS
• Mexico: Financial Sector Assessment Program Update: Technical Note: Derivatives Market: Overview and Potential Vulnerabilities
• III OTC Derivatives Markets: Size, Structure, and Business Practices
• United States: Publication of Financial Sector Assessment Program Documentation: Technical Note on Regulatory Reform: OTC Derivatives
• CHAPTER IV INSTITUTIONAL INVESTORS IN EMERGING MARKETS
• Chapter IV: Local Securities and Derivatives Markets in Emerging Markets: Selected Policy Issues
• The Derivatives Market in South Africa: Lessons for Sub-Saharan African Countries
• V Key Features of OTC Derivatives Activities
• Derivative Market Competition: OTC Versus Organized Derivative Exchanges
• CHAPTER II GLOBAL FINANCIAL MARKET DEVELOPMENTS

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Table of Contents

• Front Matter
• CHAPTER II EMERGING LOCAL BOND MARKETS
• CHAPTER III EMERGING EQUITY MARKETS
• CHAPTER IV THE ROLE OF FINANCIAL DERIVATIVES IN EMERGING MARKETS
• Back Matter
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Allen , Franklin , and Douglas Gale , 2000 , Comparing financial Systems ( Cambridge, Mass .; MIT Press ).

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Khor Hoe E. , 2001 , “Derivatives and Macro-economic Management in Post-Crisis Asia” ( Monetary Authority of Singapore ).

Kim , Woochan , and Shang-Jin Wei , 2002 , “Foreign Portfolio Investors Before and During a Crises,” Journal of International Economics , Vol, 56 ( January ), pp. 77 – 96 .

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Using Options and Futures as Tools of Capital Increase in Digital Economy

The article provides basic notions of derivative market, shows what these finance tools are, how they work and how capital can be increased with their help. By citing examples from historical development and simple conventional examples the mechanism of derivatives’ functioning was explained and their links with underlying assets were studied, for instance it was shown how the value of exchange tool can enter the negative zone. Exchange and OTC markets were analyzed, their value was investigated on the basis of historical statistics of international finance institutions and mechanisms of their interaction with regulators on the territory of the Russian Federation and abroad were researched. Strategies of using these finance tools for speculation, hedging and arbitration were demonstrated, their advantages and disadvantages were identified. As a result the authors put forward strategy of entering overestimated market with the help of options.

Investigating seasonality, policy intervention and forecasting in the Indian gold futures market: a comparison based on modeling non-constant variance using two different methods

AbstractThis study focuses on the Indian gold futures market where primary participants hold sentimental value for the underlying asset and are globally ranked number two in terms of the largest private holdings in the physical form. The trade of gold futures relates to seasons, festivity, and government policy. So, the paper will discuss seasonality and intervention in the analysis. Due to non-constant variance, we will also use the standard variance stabilization transformation method and the ARIMA/GARCH modelling method to compare the forecast performance on the gold futures prices. The results from the analysis show that while the standard variance transformation method may provide better point forecast values, the ARIMA/GARCH modelling method provides much shorter forecast intervals. The empirical results of this study which rationalise the effect of seasonality in the Indian bullion derivative market have not been reported in literature.

A Study of Derivative Market in India

The development of the market for subsidiaries items, most quite advances, fates and choices, can be followed back to the readiness of hazard disinclined financial specialists to watch themselves against vulnerabilities emerging out of vacillations in resource costs. Subordinates are hazard the board instruments, which get their worth from a hidden resource. Costs in a coordinated subordinates market mirror the view of market members about the future and lead the cost of fundamental to the apparent future level. As of late the Derivative business sectors have acquired significance as far as their essential part in the economy. The expanding interests in stocks (homegrown just as abroad) have pulled to my advantage here. Various investigations on the impacts of fates and alternatives posting on the hidden money market unpredictability have been done in the created markets. The subordinate market is recently begun in India and it isn't known by each financial backer, so SEBI needs to find ways to make mindfulness among the financial backers about the subsidiary portion. In real money market the benefit/loss of the financial backer relies upon the market cost of the basic resource. The financial backer may cause gigantic benefit or he may bring about tremendous misfortune. In any case, in subsidiaries portion the financial backer appreciates gigantic benefits with restricted drawback. Subordinates are for the most part utilized for supporting reason. To expand the subsidiaries market in India, SEBI should overhaul a portion of their guidelines like agreement size, support of FII in the subordinates market. More or less the examination illuminates the subordinates market.

Deviations from the covered interest parity: The role of fundamentals, financial and political turmoil, and market frictions

Recent studies of mature markets on covered interest parity suggest that deviations are mean-reverting, but persistent, particularly after the 2008 crisis (Du et al., 2018). Our study contributes to the literature by modeling the deviations from covered interest rate parity (CIP) of an important emerging-market economy. We focus on Brazilian data, given the importance of its derivative market. One of the strengths of our study is the use of an agnostic approach, based on an automatic model-selection technique that is robust to structural change, the Autometrics algorithm (Hendry and Doornik, 2014), to unveil the possible determinants of CIP deviations from a wide information data set. We show that CIP deviations are highly sensitive to changes in Brazilian federal government total debt, level of reserves, inflation, and degree of trade openness. We also document the existence of instability in the model due to financial and political turmoil. We reach these conclusions based on the algorithm’s intercept correction, which can be seen as a byproduct of our methodology. Finally, we find evidence that, even after correction for fundamentals and instability points, CIP deviations still have persistence, suggesting that market frictions play an important role in the dynamics of CIP deviations.

DERIVATIVE MARKETS-USING OPTIONS TRADING STRATEGY IN MONGOLIAN STOCK MARKET

This study identifies some opportunities to introduce derivative instruments based on the practical experience of other countries, and provides some estimates of the implementation of derivative market mechanisms, pricing, and trading strategies. KEY WORDS: Financial derivative, option, and spread

Does Commodity Derivatives Function Effectively? A lengthy Discussion

The present work has been designed to intensely investigate the capability of the commodity futures market in achieving the aim of price discovery. Further, the downside of the cash and futures market and transfer of the risk to other markets has also been studied using VaR, and Bivariate EGARCH. The findings of the work point that the metal commodity derivative market helps in the efficient discovery of price in the spot market except for nickel. But, in the case of the agricultural commodities, the spot is found to be leading and thus there is no price discovery except turmeric. On the other hand, the volatility spillover is bidirectional for both agri and metal commodities except copper, where volatility spills only from futures to spot. Further, the effect of negative shock informational bias differs from commodity to commodity, irrespective of metal or agriculture.

Early Results on Depth of the Nascent Kenyan Derivative Market

Despite their importance in hedging against risk and reducing price uncertainty, derivative markets remain undeveloped or absent in many African countries. This paper describes market depth using key trends observed in the Kenyan derivatives market for the first 30 weeks of trading using mixed methods. Market depth was measured by the number of open interests of 142 trading days (30 weeks. The market was described using trend analysis, tests of means, and thematic analysis. The results revealed a market highly dominated by one company's single stock futures (Safaricom Plc), whose overall trade was 68% of the 6179 open contracts. Further, the market has strong weekly swings fluctuating from no trade to a high of 326 and a weekly average of 206 contracts. The market segment of single stock futures is significantly deeper than that of equity index futures. The qualitative study attributed the results to limited knowledge on derivatives amongst investors, unclear market policies, few derivatives products, and skepticism associated with developing financial markets. The Nairobi Securities Exchange (NSE) is advised to intensify investor education, introduce market makers, add new derivatives products, and transform the Nairobi Securities Exchange Clearing House into a full Central Counterparty (CCP) structure to accelerate market depth. This will create a pathway to market depth through efficiency and reduction of operational risks.

Impact of Weather on Agriculture Commodity Market and the Price Discovery: An Empirical Analysis

This paper focused on studying the agricultural commodity prices in India and it's extreme volatility due to many reasons such as government interference, growth, market forces factors, regular floods and droughts, transport and warehousing problems, etc. These are contributing factors to demand fluctuations. In this case, the future market plays an important role in the economy. The demand for commodity futures has three particular economic functions: price discovery, price risk management, and price volatility. The future market plays a key role in the process of price discovery. The main aim of this system is to regulate prices to minimize uncertainty, to provide price signals to market traders for futures spot prices through the price discovery phase. So, this study emphasized the role of the derivative market in reducing the volatility of agricultural commodity prices in the Indian market. Keywords: volatility, future market, derivatives

A Study of Indian Derivatives Market and its Current Position in Global Financial Derivatives Market

Derivatives emerged as hedging instruments out of the need to control price risk. Earlier commodity prices were the sole concern of business community, and therefore, the derivatives on commodities were the first ones to emerge. The introduction of derivatives in India can be traced out in 1875, when the Bombay Cotton Trading Association Ltd was set up for futures trading in cotton. At present the markets for derivatives have been growing at a phenomenal pace. This paper traces the growth and current position of Indian derivatives market. Since its inception in June 2000, derivatives market has exhibited exponential growth both in terms of volume and number of contract traded. The market turnover has grown from Rs.24bn in 2000-01 to Rs. 2376tn in 2018-19. The present study is an effort to demonstrate the growth and expansion of derivatives in India during the time period 2010-11 to 2018-19. It also encompasses the scope, history, concept, types and growth of financial derivatives in India and the status of Indian derivatives market vis-à-vis global derivative market.

Big Data Analysis for Trend Recognition Using Machine Learning Techniques

Background: Machine learning is one of the most popular research areas today. It relates closely to the field of data mining, which extracts information and trends from large datasets. Aims: The objective of this paper is to (a) illustrate big data analytics for the Indian derivative market and (b) identify trends in the data. Methods: Based on input from experts in the equity domain, the data are verified statistically using data mining techniques. Specifically, ten years of daily derivative data is used for training and testing purposes. The methods that are adopted for this research work include model generation using ARIMA, Hadoop framework which comprises mapping and reducing for big data analysis. Results: The results of this work are the observation of a trend that indicates the rise and fall of price in derivatives , generation of time-series similarity graph and plotting of frequency of temporal data. Conclusion: Big data analytics is an underexplored topic in the Indian derivative market and the results from this paper can be used by investors to earn both short-term and long-term benefits.

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50 Best Finance Dissertation Topics For Research Students

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Finance Dissertation Made Easier!

Embarking on your dissertation adventure? Look no further! Choosing the right finance dissertation topics is like laying the foundation for your research journey in Finance, and we're here to light up your path. In this blog, we're diving deep into why dissertation topics in finance matter so much. We've got some golden writing tips to share with you! We're also unveiling the secret recipe for structuring a stellar finance dissertation and exploring intriguing topics across various finance sub-fields. Whether you're captivated by cryptocurrency, risk management strategies, or exploring the wonders of Internet banking, microfinance, retail and commercial banking - our buffet of Finance dissertation topics will surely set your research spirit on fire!

What is a Finance Dissertation?

Finance dissertations are academic papers that delve into specific finance topics chosen by students, covering areas such as stock markets, banking, risk management, and healthcare finance. These dissertations require extensive research to create a compelling report and contribute to the student's confidence and satisfaction in the field of Finance. Now, let's understand why these dissertations are so important and why choosing the right Finance dissertation topics is crucial!

Why Are Finance Dissertation Topics Important?

Choosing the dissertation topics for Finance students is essential as it will influence the course of your research. It determines the direction and scope of your study. You must make sure that the Finance dissertation topics you choose are relevant to your field of interest, or you may end up finding it more challenging to write. Here are a few reasons why finance thesis topics are important:

1. Relevance

Opting for relevant finance thesis topics ensures that your research contributes to the existing body of knowledge and addresses contemporary issues in the field of Finance. Choosing a dissertation topic in Finance that is relevant to the industry can make a meaningful impact and advance understanding in your chosen area.

2. Personal Interest

Selecting Finance dissertation topics that align with your interests and career goals is vital. When genuinely passionate about your research area, you are more likely to stay motivated during the dissertation process. Your interest will drive you to explore the subject thoroughly and produce high-quality work.

3. Future Opportunities

Well-chosen Finance dissertation topics can open doors to various future opportunities. It can enhance your employability by showcasing your expertise in a specific finance area. It may lead to potential research collaborations and invitations to conferences in your field of interest.

4. Academic Supervision

Your choice of topics for dissertation in Finance also influences the availability of academic supervisors with expertise in your chosen area. Selecting a well-defined research area increases the likelihood of finding a supervisor to guide you effectively throughout the dissertation. Their knowledge and guidance will greatly contribute to the success of your research.

Writing Tips for Finance Dissertation

A lot of planning, formatting, and structuring goes into writing a dissertation. It starts with deciding on topics for a dissertation in Finance and conducting tons of research, deciding on methods, and so on. However, you can navigate the process more effectively with proper planning and organisation. Below are some tips to assist you along the way, and here is a blog on the 10 tips on writing a dissertation that can give you more information, should you need it!

1. Select a Manageable Topic

Choosing Finance research topics within the given timeframe and resources is important. Select a research area that interests you and aligns with your career goals. It will help you stay inspired throughout the dissertation process.

2. Conduct a Thorough Literature Review

A comprehensive literature review forms the backbone of your research. After choosing the Finance dissertation topics, dive deep into academic papers, books, and industry reports, gaining a solid understanding of your chosen area to identify research gaps and establish the significance of your study.

3. Define Clear Research Objectives

Clearly define your dissertation's research questions and objectives. It will provide a clear direction for your research and guide your data collection, analysis, and overall structure. Ensure your objectives are specific, measurable, achievable, relevant, and time-bound (SMART).

4. Collect and Analyse Data

Depending on your research methodology and your Finance dissertation topics, collect and analyze relevant data to support your findings. It may involve conducting surveys, interviews, experiments, and analyzing existing datasets. Choose appropriate statistical techniques and qualitative methods to derive meaningful insights from your data.

5. Structure and Organization

Pay attention to the structure and organization of your dissertation. Follow a logical progression of chapters and sections, ensuring that each chapter contributes to the overall coherence of your study. Use headings, subheadings, and clear signposts to guide the reader through your work.

6. Proofread and Edit

Once you have completed the writing process, take the time to proofread and edit your dissertation carefully. Check for clarity, coherence, and proper grammar. Ensure that your arguments are well-supported, and eliminate any inconsistencies or repetitions. Pay attention to formatting, citation styles, and consistency in referencing throughout your dissertation.

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Finance Dissertation Topics

Now that you know what a finance dissertation is and why they are important, it's time to have a look at some of the best Finance dissertation topics. For your convenience, we have segregated these topics into categories, including cryptocurrency, risk management, internet banking, and so many more. So, let's dive right in and explore the best Finance dissertation topics:

Dissertation topics in Finance related to Cryptocurrency

1. The Impact of Regulatory Frameworks on the Volatility and Liquidity of Cryptocurrencies.

2. Exploring the Factors Influencing Cryptocurrency Adoption: A Comparative Study.

3. Assessing the Efficiency and Market Integration of Cryptocurrency Exchanges.

4. An Analysis of the Relationship between Cryptocurrency Prices and Macroeconomic Factors.

5. The Role of Initial Coin Offerings (ICOs) in Financing Startups: Opportunities and Challenges.

Dissertation topics in Finance related to Risk Management

1. The Effectiveness of Different Risk Management Strategies in Mitigating Financial Risks in Banking Institutions.

2. The Role of Derivatives in Hedging Financial Risks: A Comparative Study.

3. Analyzing the Impact of Risk Management Practices on Firm Performance: A Case Study of a Specific Industry.

4. The Use of Stress Testing in Evaluating Systemic Risk: Lessons from the Global Financial Crisis.

5. Assessing the Relationship between Corporate Governance and Risk Management in Financial Institutions.

Dissertation topics in Finance related to Internet Banking

1. Customer Adoption of Internet Banking: An Empirical Study on Factors Influencing Usage.

Enhancing Security in Internet Banking: Exploring Biometric Authentication Technologies.

2. The Impact of Mobile Banking Applications on Customer Engagement and Satisfaction.

3. Evaluating the Efficiency and Effectiveness of Internet Banking Services in Emerging Markets.

4. The Role of Social Media in Shaping Customer Perception and Adoption of Internet Banking.

Dissertation topics in Finance related to Microfinance

1. The Impact of Microfinance on Poverty Alleviation: A Comparative Study of Different Models.

2. Exploring the Role of Microfinance in Empowering Women Entrepreneurs.

3. Assessing the Financial Sustainability of Microfinance Institutions in Developing Countries.

4. The Effectiveness of Microfinance in Promoting Rural Development: Evidence from a Specific Region.

5. Analyzing the Relationship between Microfinance and Entrepreneurial Success: A Longitudinal Study.

Dissertation topics in Finance related to Retail and Commercial Banking

1. The Impact of Digital Transformation on Retail and Commercial Banking: A Case Study of a Specific Bank.

2. Customer Satisfaction and Loyalty in Retail Banking: An Analysis of Service Quality Dimensions.

3. Analyzing the Relationship between Bank Branch Expansion and Financial Performance.

4. The Role of Fintech Startups in Disrupting Retail and Commercial Banking: Opportunities and Challenges.

5. Assessing the Impact of Mergers and Acquisitions on the Performance of Retail and Commercial Banks.

Dissertation topics in Finance related to Alternative Investment

1. The Performance and Risk Characteristics of Hedge Funds: A Comparative Analysis.

2. Exploring the Role of Private Equity in Financing and Growing Small and Medium-Sized Enterprises.

3. Analyzing the Relationship between Real Estate Investments and Portfolio Diversification.

4. The Potential of Impact Investing: Evaluating the Social and Financial Returns.

5. Assessing the Risk-Return Tradeoff in Cryptocurrency Investments: A Comparative Study.

Dissertation topics in Finance related to International Affairs

1. The Impact of Exchange Rate Volatility on International Trade: A Case Study of a Specific Industry.

2. Analyzing the Effectiveness of Capital Controls in Managing Financial Crises: Comparative Study of Different Countries.

3. The Role of International Financial Institutions in Promoting Economic Development in Developing Countries.

4. Evaluating the Implications of Trade Wars on Global Financial Markets.

5. Assessing the Role of Central Banks in Managing Financial Stability in a Globalized Economy.

Dissertation topics in Finance related to Sustainable Finance

1. The impact of sustainable investing on financial performance.

2. The role of green bonds in financing climate change mitigation and adaptation.

3. The development of carbon markets.

4. The use of environmental, social, and governance (ESG) factors in investment decision-making.

5. The challenges and opportunities of sustainable Finance in emerging markets.

Dissertation topics in Finance related to Investment Banking

1. The valuation of distressed assets.

2. The pricing of derivatives.

3. The risk management of financial institutions.

4. The regulation of investment banks.

5. The impact of technology on the investment banking industry.

Dissertation topics in Finance related to Actuarial Science

1. The development of new actuarial models for pricing insurance products.

2. The use of big data in actuarial analysis.

3. The impact of climate change on insurance risk.

4. The design of pension plans that are sustainable in the long term.

5. The use of actuarial science to manage risk in other industries, such as healthcare and Finance.

Tips To Find Good Finance Dissertation Topics 

Embarking on a financial dissertation journey requires careful consideration of various factors. Your choice of topic in finance research topics is pivotal, as it sets the stage for the entire research process. Finding a good financial dissertation topic is essential to blend your interests with the current trends in the financial landscape. We suggest the following tips that can help you pick the perfect dissertation topic:

1. Identify your interests and strengths 

2. Check for current relevance

3. Feedback from your superiors

4. Finalise the research methods

5. Gather the data

6. Work on the outline of your dissertation

7. Make a draft and proofread it

In this blog, we have discussed the importance of finance thesis topics and provided valuable writing tips and tips for finding the right topic, too. We have also presented a list of topics within various subfields of Finance. With this, we hope you have great ideas for finance dissertations. Good luck with your finance research journey!

Frequently Asked Questions

How do i research for my dissertation project topics in finance, what is the best topic for dissertation topics for mba finance, what is the hardest finance topic, how do i choose the right topic for my dissertation in finance, where can i find a dissertation topic in finance.

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The unexpected origins of a modern finance tool

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In the early 1600s, the officials running Durham Cathedral, in England, had serious financial problems. Soaring prices had raised expenses. Most cathedral income came from renting land to tenant farmers, who had long leases so officials could not easily raise the rent. Instead, church leaders started charging periodic fees, but these often made tenants furious. And the 1600s, a time of religious schism, was not the moment to alienate church members.

But in 1626, Durham officials found a formula for fees that tenants would accept. If tenant farmers paid a fee equal to one year’s net value of the land, it earned them a seven-year lease. A fee equal to 7.75 years of net value earned a 21-year lease.

This was a form of discounting, the now-common technique for evaluating the present and future value of money by assuming a certain rate of return on that money. The Durham officials likely got their numbers from new books of discounting tables. Volumes like this had never existed before, but suddenly local church officials were applying the technique up and down England.

As financial innovation stories go, this one is unusual. Normally, avant-garde financial tools might come from, well, the financial avant-garde — bankers, merchants, and investors hunting for short-term profits, not clergymen.

“Most people have assumed these very sophisticated calculations would have been implemented by hard-nosed capitalists, because really powerful calculations would allow you to get an economic edge and increase profits,” says MIT historian William Deringer, an expert in the deployment of quantitative reasoning in public life. “But that was not the primary or only driver in this situation.”

Deringer has published a new research article about this episode, “ Mr. Aecroid’s Tables: Economic Calculations and Social Customs in the Early Modern Countryside ,” appearing in the current issue of the Journal of Modern History . In it, he uses archival research to explore how the English clergy started using discounting, and where. And one other question: Why?

Enter inflation

Today, discounting is a pervasive tool. A dollar in the present is worth more than a dollar a decade from now, since one can earn money investing it in the meantime. This concept heavily informs investment markets, corporate finance, and even the NFL draft (where trading this year’s picks yields a greater haul of future picks). As the historian William N. Goetzmann has written, the related idea of net present value “is the most important tool in modern finance.” But while discounting was known as far back as the mathematician Leonardo of Pisa (often called Fibonacci) in the 1200s, why were English clergy some of its most enthusiastic early adopters?

The answer involves a global change in the 1500s: the “price revolution,” in which things began costing more, after a long period when prices had been constant. That is, inflation hit the world.

“People up to that point lived with the expectation that prices would stay the same,” Deringer says. “The idea that prices changed in a systematic way was shocking.”

For Durham Cathedral, inflation meant the organization had to pay more for goods while three-quarters of its revenues came from tenant rents, which were hard to alter. Many leases were complex, and some were locked in for a tenant’s lifetime. The Durham leaders did levy intermittent fees on tenants, but that led to angry responses and court cases.

Meanwhile, tenants had additional leverage against the Church of England: religious competition following the Reformation. England’s political and religious schisms would lead it to a midcentury civil war. Maybe some private landholders could drastically increase fees, but the church did not want to lose followers that way.

“Some individual landowners could be ruthlessly economic, but the church couldn’t, because it’s in the midst of incredible political and religious turmoil after the Reformation,” Deringer says. “The Church of England is in this precarious position. They’re walking a line between Catholics who don’t think there should have been a Reformation, and Puritans who don’t think there should be bishops. If they’re perceived to be hurting their flock, it would have real consequences. The church is trying to make the finances work but in a way that’s just barely tolerable to the tenants.”

Enter the books of discounting tables, which allowed local church leaders to finesse the finances. Essentially, discounting more carefully calibrated the upfront fees tenants would periodically pay. Church leaders could simply plug in the numbers as compromise solutions.

In this period, England’s first prominent discounting book with tables was published in 1613; its most enduring, Ambrose Acroyd’s “Table of Leasses and Interest,” dated to 1628-29. Acroyd was the bursar at Trinity College at Cambridge University, which as a landholder (and church-affiliated institution) faced the same issues concerning inflation and rent. Durham Cathedral began using off-the-shelf discounting formulas in 1626, resolving decades of localized disagreement as well.

Performing fairness

The discounting tables from books did not only work because the price was right. Once circulating clergy had popularized the notion throughout England, local leaders could justify using the books because others were doing it. The clergy were “performing fairness,” as Deringer puts it.

“Strict calculative rules assured tenants and courts that fines were reasonable, limiting landlords’ ability to maximize revenues,” Deringer writes in the new article.

To be sure, local church leaders in England were using discounting for their own economic self-interest. It just wasn’t the largest short-term economic self-interest possible. And it was a sound strategy.

“In Durham they would fight with tenants every 20 years [in the 1500s] and come to a new deal, but eventually that evolves into these sophisticated mechanisms, the discounting tables,” Deringer adds. “And you get standardization. By about 1700, it seems like these procedures are used everywhere.”

Thus, as Deringer writes, “mathematical tables for setting fines were not so much instruments of a capitalist transformation as the linchpin holding together what remained of an older system of customary obligations stretched nearly to breaking by macroeconomic forces.”

Once discounting was widely introduced, it never went away. Deringer’s Journal of Modern History article is part of a larger book project he is currently pursuing, about discounting in many facets of modern life.

Deringer was able to piece together the history of discounting in 17th-century England thanks in part to archival clues. For instance, Durham University owns a 1686 discounting book self-described as an update to Acroyd’s work; that copy was owned by a Durham Cathedral administrator in the 1700s. Of the 11 existing copies of Acroyd’s work, two are at Canterbury Cathedral and Lincoln Cathedral.

Hints like that helped Deringer recognize that church leaders were very interested in discounting; his further research helped him see that this chapter in the history of discounting is not merely about finance; it also opens a new window into the turbulent 1600s.

“I never expected to be researching church finances, I didn’t expect it to have anything to do with the countryside, landlord-tenant relationships, and tenant law,” Deringer says. “I was seeing this as an interesting example of a story about bottom-line economic calculation, and it wound up being more about this effort to use calculation to resolve social tensions.” 

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Conferences, 2024 financial stability conference – call for papers.

Published: June 4, 2024

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The Federal Reserve Bank of Cleveland and the Office of Financial Research invite the submission of research and policy-oriented papers for the 2024 Financial Stability Conference on November 21–22, 2024. The conference will be held in person in Cleveland, Ohio, and virtually.

Markets and institutions, increasingly interconnected, are being challenged by the dizzying pace of changes in the financial system, accelerating the buildup of risk and threats to solvency. Regulatory adaptations add another layer of complexity to the issue. Increasingly sophisticated algorithms and the rise of generative artificial intelligence may create new vulnerabilities across the system as banks, nonbank financial institutions, and financial markets exploit nascent opportunities. The twelfth annual conference will explore how firms and markets can become resilient or even antifragile and how regulators can encourage and accommodate needed changes.

Conference Format

The conference will bring together policymakers, market participants, and researchers in two types of sessions:

• Policy Discussions These sessions include keynote addresses and panel discussions in which participants from industry, regulatory agencies, and academia share their insights.
• Research Forums These forums follow the format of an academic workshop and comprise sessions to discuss submitted papers.

We welcome submissions of research on topics related to potential financial stability risks faced by financial markets and institutions, sources of financial system resilience, and related public policy. Conference topics include but are not limited to the following:

Emerging Risks

As the financial system continues to evolve, new risks emerge along with new businesses, new strategies, and new technologies. Old problems take on new dimensions as fiscal and monetary policies adapt to new economic and political realities, thereby adding new stresses to regulatory frameworks that themselves struggle to adapt. As information technology moves risk out of closely regulated sectors, it also creates new vulnerabilities from cyber-attacks. A rapidly changing physical environment and the prospect of nonhuman intelligences add even more uncertainty.

• Financial stability concerns related to faster payments and equity transactions such as the implementation of t+1 settlement
• The financial stability implications of generative AI and deep learning
• Cryptocurrencies, smart contracts, and blockchain
• Cyber-attacks
• Climate risk
• Interaction of monetary policy with macroprudential supervision
• Sources of resilience in the financial sector

Financial Institutions

A riskier macroeconomic environment poses challenges for financial institutions and their supervisors. Risk management tools and strategies will be tested by fluctuations in inflation and output and by new regulations designed to mitigate vulnerabilities. Network effects, including interactions with a rapidly evolving fintech and crypto sector, may lead to further risks at a systemic level. How are institutions adapting to these risks and associated regulatory changes? How prepared are regulators and policymakers? Are existing microprudential and macroprudential toolkits sufficient?

• Bank lending to nonbank financial institutions (NBFI)
• Insurance markets
• Banking as a service (BaaS)
• Regional banks
• Interest rate risk
• Risks of rapid growth
• Unrealized losses on balance sheets and mark-to-market accounting
• Impact of reforms to lenders of last resort, deposit Insurance, capital rules, and the FHLB system

Financial Markets

Inflation and the associated responses of central banks around the world have contributed to stress to financial markets that has not been seen in the recent past. Financial stability threats may arise from resulting reallocations through volatility spikes, fire sales, and financial contagion. The continued development of algorithms, decentralized finance (DeFi), and complex artificial intelligence has the potential to add novel risks to financial markets. To what extent do investors recognize these risks, and how does recognition affect investors’ allocations? How does opacity resulting from deficiencies in reporting, risk management, and operation standards for these risks affect investor behavior?

• Risks associated with high levels and issuance of public debt (for example, recent volatility around Treasury funding announcements, concerns about primary dealers and principal trading firms, the SEC’s recent rule about what defines a dealer and what that might mean for Treasury markets)
• Short-term funding
• Implications of deficits, central bank balance sheet policies, and financial stability
• The impact of technological innovation on financial markets

Real Estate Markets

Real estate is often one of the sectors most affected by and can be a cause of financial instability. Construction and housing play a major role in the transmission of monetary policy, and real estate-based lending remains a major activity of banks, insurance companies, and mortgage companies. A complex and active securities market ties together financial institutions and markets in both residential and commercial real estate.

• Commercial real estate (CRE)
• Nonbank originators and servicers
• International contagion
• Implications of remote work and the impact of COVID-19
• Effects of monetary policy on real estate markets

Scientific Committee

• Vikas Agarwal, Georgia State University
• Marco Di Maggio, Harvard University
• Michael Fleming, Federal Reserve Bank of New York
• Rod Garratt, University of California, Santa Barbara
• Mariassunta Giannetti, Stockholm School of Economics
• Arpit Gupta, New York University, Stern School of Business
• Zhiguo He, Stanford University
• Zhaogang Song, Johns Hopkins University
• Russell R. Wermers, Robert H. Smith School of Business, The University of Maryland at College Park

Paper Submission Procedure

The deadline for submissions is Friday, July 5, 2024. Please submit completed papers through Conference Maker . Notification of acceptance will be provided by Friday, September 6, 2024. Final conference papers are due on Friday, November 1, 2024. In-person paper presentations are preferred. Questions should be directed to [email protected] .

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Methodology for Savings, Money Market, and CD Rankings

We make it easy to find top savings rates by giving you daily rankings of the best rates for savings accounts, money market accounts (MMAs), and certificates of deposit (CDs). And because we list the best-paying accounts based simply on APY, not on which financial institutions advertise with us, you can feel confident you’re seeing a list of the truly best options available.

We have been researching and publishing the best rates for CDs, savings accounts, and MMAs since 2019. We carefully evaluate the financial institutions and accounts we include in our lists, and they must meet threshold criteria in order to qualify. This guide explains those criteria and how our ranking process works.  

How We Find the Best Rates

Our universe of nationally available banks and credit unions includes about 200 physical and online institutions. About 200 of these offer CDs that meet our criteria, 100 offer what we call high-yield savings accounts, and 60 provide money market accounts.

Our team tracks the deposit rates at these institutions every business day, through a combination of automated and human processes, to ensure we find every great rate and update any out-of-date rates. We also regularly add institutions as they expand their availability or we learn of new nationwide players.

Most institutions update their rates online in the morning hours across multiple time zones, and our process for collecting any new rates data takes place throughout the day. We update our lists every business day, and the "updated" date on the page will tell you if the page has been updated for the day.

See which rates met our criteria with our picks for the best CDs , best high-yield savings accounts , and best money market accounts .

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To be eligible for inclusion in our deposit account rankings, financial institutions need to meet two primary criteria. They must be:

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Federally Insured

For banks, this means they are a member of the FDIC and for credit unions, a member of the NCUA . This ensures that every customer’s deposits up to $250,000 (per person,  per institution, and per ownership category—e.g., single account or joint account) are protected by the U.S. government should the institution fail or be seized. By only including FDIC and NCUA members in our rankings, you can rest assured that funds (up to $250,000) deposited with these institutions will be safe.

Along these lines, note that this means both brick-and-mortar and online banks are eligible for inclusion. If an online bank has FDIC insurance, deposits are just as safe there as at any other FDIC institution, regardless of whether the bank operates any physical branches.

Available Nationwide

To best serve our readers nationwide, we only include banks and credit unions that accept customers from across the country. This generally means that online account opening is available and residency in any U.S. state is acceptable. 

We do make a few exceptions for banks that serve most but not all of the country; our threshold for being considered a nationwide bank is that it must serve customers from at least 40 states. The vast majority of the banks in our rankings do indeed serve all 50 states, but when that’s not the case, we indicate the exclusions with an asterisk.

Credit unions operate a bit differently in that they require membership. Eligibility for joining, called the “field of membership,” is often based on living in a particular geographic region or working for a certain employer.

But many credit unions open their doors to customers nationwide with a special pathway for those who don’t otherwise meet the requirements. Sometimes this is free and other times it requires a one-time donation or membership fee to the credit union’s nonprofit affiliate. In all of our articles on the best CDs, savings accounts, and money market accounts, we explain what is required to gain membership to the credit unions we include, while excluding any whose required donation is $40 or more. 

Savings Accounts and Money Market Accounts That Qualify

For our rankings of high-yield savings accounts and money market accounts, we include those whose minimum balance to earn the high rate is no more than $25,000. Also, we disqualify those that cap their high-yield rate to only low balances, defined for our purposes as below $5,000. In other words, a savings account that advertises a high APY but only applies it to the first $1,000 of your balance would not qualify for our rankings.

In addition, we distinguish between savings accounts and money market accounts on the basis of check-writing privileges. Historically, money market accounts have allowed check writing and savings accounts have not, and we follow that traditional definition in our methodology. 

Note, however, that “money market” has evolved to be used as a marketing term, with some banks including it in the name of their savings account even when it does not include check writing. For our purposes, if the account does not permit check writing, it is eligible for our savings account rankings. If it does allow checks, it can be in our money market account rankings.

Lastly, for any savings or money market account that is accessible only through a mobile app, we require that the app be available on both the iOS and Android platforms.

Certificates of Deposit That Qualify

Certificates of deposit can be considered for our standard CD rankings if they require a minimum initial deposit of no more than $25,000. Those with a required deposit of $50,000 to $100,000 qualify for our jumbo CD rankings. Though some CDs exist in the marketplace for balances of at least $250,000, the offerings are limited and we do not track nor rank these oft-called “super jumbo” certificates. 

In addition, if a CD specifies a maximum allowable deposit, that maximum cannot be under $5,000. This disqualifies special promotional CDs that offer a very high rate but on a very small deposit amount, like a $1,000 maximum.

We also exclude CDs from our definition of jumbo CDs that have a rate that’s not higher than what you could get from that institution for a deposit of less than $50,000. These are not really jumbo CDs, but rather, standard CDs marketed as jumbos.

To qualify for our rankings, CDs must also have a fixed rate that is known for the duration of the term. For this reason, certificates that are indexed, sometimes called “flex CDs” or “ variable-rate CDs ,” do not qualify, as their rate will fluctuate up or down with some unpredictable indicator, such as the prime rate or federal funds rate . 

One exception is “bump-up” certificates that offer you the option to raise your rate during the term, usually just once and at your initiation. Since you are still guaranteed the original rate if you would like it for the full term, and since exercising the raised rate option would only improve your return, we do allow these certificates in our CD rankings.

Ranking Order for Savings and Money Market Accounts

Among all the nationwide high-yield savings accounts or money market accounts that qualify for our lists, we rank them in order of interest rate, with those paying the highest APY topping the list. When two accounts pay the same rate, our next sorting criteria is the ongoing balance required to earn the APY. So, for example, an account requiring a $500 ongoing balance would rank higher than one requiring you to keep $10,000 in the account. If there is still a tie after considering the minimum ongoing balance, we rank based on the lowest required initial deposit. Ties after that are settled alphabetically.

Ranking Order for Certificates of Deposit

Certificates of deposit are initially ranked similarly to savings and MMA accounts, with the CD paying the highest APY sorted to the top. The first tie-breaker between any identical rates is the certificate’s maturity term, or duration. Those with a shorter duration are ranked higher than those with a longer term. This is important because not every CD has a standard term of 3, 6, 12, etc. months, with many odd-term certificates existing in the marketplace. We therefore group CDs in term ranges, such as 5-9 months for the 6-month CD ranking, 10-14 months for the 1-year CD ranking, and so forth.

When two CDs are tied both in APY and term, the third sort criteria is the minimum required deposit, with those requiring a smaller deposit ranking above those requiring a large funds commitment. If still tied after this third sort, the CDs are listed alphabetically.

When deciding where to stash your cash, shopping around can make a world of financial difference. Going with a top rate versus an average rate can net you hundreds or even thousands of dollars over time.

Our rankings aim to make your decision-making on a savings, money market, or CD account as easy as possible by distilling the rates data from thousands of deposit products and presenting you with the best-paying options. But the account you choose is still a personal decision. You may already have a relationship with an institution that is paying the seventh-best rate instead of the best, making that one much more convenient.

Or you may want to avoid a particular institution based on a negative past experience, or want to stick with a bank instead of a credit union. Account features like minimum deposit, CD term, and so forth can also make one product a better fit for you than another.

That’s why our rankings typically include 15 or more options for every product type, so you can choose the best one for your situation, confident that any one of them is among the top-paying accounts in the nation.

Sabrina Karl

Yasmin ghahremani.

Yasmin Ghahremani is an Associate Editorial Director at Investopedia, where she oversees educational content about consumer financial products, ranging from checking accounts to life insurance. She joined the team in January 2023, after working for nearly four years in a similar role at The Balance. She has more than a decade of experience educating consumers about personal finance, which also includes stints as a managing editor at CreditCards.com and Wise Bread, and a contract editor at LendingTree.

Yasmin has also had an extensive international career covering business, technology, and the environment for broadcast and print outlets, including CNN, CNBC, and Asiaweek magazine. She has a Master of International Affairs degree from Columbia University.

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• The State of the American Middle Class

Who is in it and key trends from 1970 to 2023

Table of contents.

• Acknowledgments

This report examines key changes in the economic status of the American middle class from 1970 to 2023 and its demographic attributes in 2022. The historical analysis is based on U.S. Census Bureau data from the Annual Social and Economic Supplements (ASEC) of the Current Population Survey (CPS). The demographic analysis is based on data from the American Community Survey (ACS). The data is sourced from IPUMS CPS and IPUMS USA , respectively.  

The CPS, a survey of about 60,000 households, is the U.S. government’s official source for monthly estimates of unemployment . The CPS ASEC, conducted in March each year, is the official source of U.S. government estimates of income and poverty . Our analysis of CPS data starts with the 1971 CPS ASEC, which records the incomes of households in 1970. It is also the first year for which data on race and ethnicity is available. The latest available CPS ASEC file is for 2023, which reports on household incomes in 2022.

The public-use version of the ACS is a 1% sample of the U.S. population, or more than 3 million people. This allows for a detailed study of the demographic characteristics of the middle class, including its status in U.S. metropolitan areas. But ACS data is available only from 2005 onward and is less suitable for long-term historical analyses. The latest available ACS data is for 2022.

Middle-income households are defined as those with an income that is two-thirds to double that of the U.S. median household income, after incomes have been adjusted for household size. Lower-income households have incomes less than two-thirds of the median, and upper-income households have incomes that are more than double the median. When using American Community Survey (ACS) data, incomes are also adjusted for cost of living in the areas in which households are located.

Estimates of household income are scaled to reflect a household size of three and expressed in 2023 dollars. In the Current Population Survey (CPS), household income refers to the calendar year prior to the survey year. Thus, the income data in the report refers to the 1970-2022 period, and the share of Americans in each income tier from the CPS refers to the 1971-2023 period.

The demographic attributes of Americans living in lower-, middle- or upper-income tiers are derived from ACS data. Except as noted, estimates pertain to the U.S. household population, excluding people living in group quarters.

The terms middle class and middle income are used interchangeably in this report.

White, Black, Asian, American Indian or Alaska Native, and Native Hawaiian or Pacific Islander include people who identified with a single major racial group and who are not Hispanic. Multiracial includes people who identified with more than one major racial group and are not Hispanic. Hispanics are of any race.

U.S. born refers to individuals who are U.S. citizens at birth, including people born in the 50 U.S. states, the District of Columbia, Puerto Rico or other U.S. territories, as well as those born elsewhere to at least one parent who is a U.S. citizen. The terms foreign born and immigrant are used interchangeably in this report. They refer to people who are not U.S. citizens at birth.

Occupations describe the broad kinds of work people do on their job. For example, health care occupations include doctors, nurses, pharmacists and others who are directly engaged in the provision of health care. Industries describe the broad type of products companies produce. Each industry encompasses a variety of occupations. For example, the health care and social assistance industry provides services that are produced by a combination of doctors, managers, technology and administrative staff, food preparation workers, and workers in other occupations.

The share of Americans who are in the middle class is smaller than it used to be. In 1971, 61% of Americans lived in middle-class households. By 2023, the share had fallen to 51%, according to a new Pew Research Center analysis of government data.

As a result, Americans are more apart than before financially. From 1971 to 2023, the share of Americans who live in lower-income households increased from 27% to 30%, and the share in upper-income households increased from 11% to 19%.

Notably, the increase in the share who are upper income was greater than the increase in the share who are lower income. In that sense, these changes are also a sign of economic progress overall.

But the middle class has fallen behind on two key counts. The growth in income for the middle class since 1970 has not kept pace with the growth in income for the upper-income tier. And the share of total U.S. household income held by the middle class has plunged.

Moreover, many groups still lag in their presence in the middle- and upper-income tiers. For instance, American Indians or Alaska Natives, Black and Hispanic Americans, and people who are not married are more likely than average to be in the lower-income tier. Several metro areas in the U.S. Southwest also have high shares of residents who are in the lower-income tier, after adjusting for differences in cost of living across areas.

• Change in income
• Share of total U.S. household income
• Race and ethnicity
• Marital status
• Veteran status
• Place of birth
• Employment status
• Metropolitan area of residence

Our report focuses on the current state of the American middle class. First, we examine changes in the financial well-being of the middle class and other income tiers since 1970. This is based on data from the Annual Social and Economic Supplements (ASEC) of the Current Population Survey (CPS), conducted from 1971 to 2023.

Then, we report on the attributes of people who were more or less likely to be middle class in 2022. Our focus is on their race and ethnicity , age , gender, marital and veteran status , place of birth , ancestry , education , occupation , industry , and metropolitan area of residence . These estimates are derived from American Community Survey (ACS) data and differ slightly from the CPS-based estimates. In part, that is because incomes can be adjusted for the local area cost of living only with the ACS data. (Refer to the methodology for details on these two data sources.)

This analysis and an accompanying report on the Asian American middle class are part of a series on the status of America’s racial and ethnic groups in the U.S. middle class and other income tiers. Forthcoming analyses will focus on White, Black, Hispanic, American Indian or Alaska Native, Native Hawaiian or Pacific Islander and multiracial Americans, including subgroups within these populations. These reports are, in part, updates of previous work by the Center . But they offer much greater detail on the demographic attributes of the American middle class.

Following are some key facts about the state of the American middle class:

In our analysis, “middle-income” Americans are those living in households with an annual income that is two-thirds to double the national median household income. The income it takes to be middle income varies by household size, with smaller households requiring less to support the same lifestyle as larger households. It also varies by the local cost of living, with households in a more expensive area, such as Honolulu, needing a higher income than those in a less expensive area, such as Wichita, Kansas.

We don’t always know the area in which a household is located. In our two data sources – the Current Population Survey, Annual Social and Economic Supplement (CPS ASEC) and the American Community Survey (ACS) – only the latter provides that information, specifically the metropolitan area of a household. Thus, we aren’t able to adjust for the local cost of living when using the CPS to track changes in the status of the middle class over time. But we do adjust for the metropolitan area cost of living when using the ACS to determine the demographic attributes of the middle class in 2022.

In the 2023 CPS ASEC data , which reports income for 2022, middle-income households with three people have incomes ranging from about $61,000 to $183,000 annually. “Lower-income” households have incomes less than $61,000, and “upper-income” households have incomes greater than $183,000.

In the 2022 ACS data , middle-income households with three people have incomes ranging from about $62,000 to $187,000 annually, with incomes also adjusted for the local area cost of living. (Incomes are expressed in 2023 dollars.)

The boundaries of the income tiers also vary across years as the national median income changes.

The terms “middle income” and “middle class” are used interchangeably in this report for the sake of exposition. But being middle class can refer to more than just income , be it education level, type of profession, economic security, home ownership or social and political values. Class also could simply be a matter of self-identification .

Households in all income tiers had much higher incomes in 2022 than in 1970, after adjusting for inflation. But the gains for middle- and lower-income households were less than the gains for upper-income households .

The median income of middle-class households increased from about $66,400 in 1970 to $106,100 in 2022, or 60%. Over this period, the median income of upper-income households increased 78%, from about $144,100 to $256,900. (Incomes are scaled to a three-person household and expressed in 2023 dollars.)

The median income of lower-income households grew more slowly than that of other households, increasing from about $22,800 in 1970 to $35,300 in 2022, or 55%.

Consequently, there is now a larger gap between the incomes of upper-income households and other households. In 2022, the median income of upper-income households was 7.3 times that of lower-income households, up from 6.3 in 1970. It was 2.4 times the median income of middle-income households in 2022, up from 2.2 in 1970.

The share of total U.S. household income held by the middle class has fallen almost without fail in each decade since 1970 . In that year, middle-income households accounted for 62% of the aggregate income of all U.S. households, about the same as the share of people who lived in middle-class households.

By 2022, the middle-class share in overall household income had fallen to 43%, less than the share of the population in middle-class households (51%). Not only do a smaller share of people live in the middle class today, the incomes of middle-class households have also not risen as quickly as the incomes of upper-income households.  

Over the same period, the share of total U.S. household income held by upper-income households increased from 29% in 1970 to 48% in 2022. In part, this is because of the increase in the share of people who are in the upper-income tier.

The share of overall income held by lower-income households edged down from 10% in 1970 to 8% in 2022. This happened even though the share of people living in lower-income households increased over this period.

The share of people in the U.S. middle class varied from 46% to 55% across racial and ethnic groups in 2022. Black and Hispanic Americans, Native Hawaiians or Pacific Islanders, and American Indians or Alaska Natives were more likely than others to be in lower-income households .

In 2022, 39% to 47% of Americans in these four groups lived in lower-income households. In contrast, only 24% of White and Asian Americans and 31% of multiracial Americans were in the lower-income tier.

At the other end of the economic spectrum, 27% of Asian and 21% of White Americans lived in upper-income households in 2022, compared with about 10% or less of Black and Hispanic Americans, Native Hawaiians or Pacific Islanders, and American Indians or Alaska Natives.

Not surprisingly, lower-income status is correlated with the likelihood of living in poverty. According to the Census Bureau , the poverty rate among Black (17.1%) and Hispanic (16.9%) Americans and American Indians or Alaska Natives (25%) was greater than the rate among White and Asian Americans (8.6% for each). (The Census Bureau did not report the poverty rate for Native Hawaiians or Pacific Islanders.)

Children and adults 65 and older were more likely to live in lower-income households in 2022. Adults in the peak of their working years – ages 30 to 64 – were more likely to be upper income. In 2022, 38% of children (including teens) and 35% of adults 65 and older were lower income, compared with 26% of adults ages 30 to 44 and 23% of adults 45 to 64.

The share of people living in upper-income households ranged from 13% among children and young adults (up to age 29) to 24% among those 45 to 64. In each age group, about half or a little more were middle class in 2022.

Men were slightly more likely than women to live in middle-income households in 2022 , 53% vs. 51%. Their share in upper-income households (18%) was also somewhat greater than the share of women (16%) in upper-income households.

Marriage appears to boost the economic status of Americans. Among those who were married in 2022, eight-in-ten lived either in middle-income households (56%) or upper-income households (24%). In contrast, only about six-in-ten of those who were separated, divorced, widowed or never married were either middle class or upper income, while 37% lived in lower-income households.

Veterans were more likely than nonveterans to be middle income in 2022, 57% vs. 53%. Conversely, a higher share of nonveterans (29%) than veterans (24%) lived in lower-income households.

Immigrants – about 14% of the U.S. population in 2022 – were less likely than the U.S. born to be in the middle class and more likely to live in lower-income households. In 2022, more than a third of immigrants (36%) lived in lower-income households, compared with 29% of the U.S. born. Immigrants also trailed the U.S. born in the shares who were in the middle class, 48% vs. 53%.

There are large gaps in the economic status of American residents by their region of birth. Among people born in Asia, Europe or Oceania, 25% lived in upper-income households in 2022. People from these regions represented 7% of the U.S. population.

By comparison, only 14% of people born in Africa or South America and 6% of those born in Central America and the Caribbean were in the upper-income tier in 2022. Together they accounted for 8% of the U.S. population.

The likelihood of being in the middle class or the upper-income tier varies considerably with the ancestry of Americans. In 2022, Americans reporting South Asian ancestry were about as likely to be upper income (38%) as they were to be middle income (42%). Only 20% of Americans of South Asian origin lived in lower-income households. South Asians accounted for about 2% of the U.S. population of known origin groups in 2022.

At least with respect to the share who were lower income, this was about matched by those with Soviet, Eastern European, other Asian or Western European origins. These groups represented the majority (54%) of the population of Americans whose ancestry was known in 2022.

On the other hand, only 7% of Americans with Central and South American or other Hispanic ancestry were in the upper-income tier, and 44% were lower income. The economic statuses of Americans with Caribbean, sub-Saharan African or North American ancestry were not very different from this.

Education matters for moving into the middle class and beyond, and so do jobs. Among Americans ages 25 and older in 2022, 52% of those with a bachelor’s degree or higher level of education lived in middle-class households and another 35% lived in upper-income households.

In sharp contrast, 42% of Americans who did not graduate from high school were in the middle class, and only 5% were in the upper-income tier. Further, only 12% of college graduates were lower income, compared with 54% of those who did not complete high school.

Not surprisingly, having a job is strongly linked to movement from the lower-income tier to the middle- and upper-income tiers. Among employed American workers ages 16 and older, 58% were in the middle-income tier in 2022 and 23% were in the upper-income tier. Only 19% of employed workers were lower income, compared with 49% of unemployed Americans.

In some occupations, about nine-in-ten U.S. workers are either in the middle class or in the upper-income tier, but in some other occupations almost four-in-ten workers are lower income. More than a third (36% to 39%) of workers in computer, science and engineering, management, and business and finance occupations lived in upper-income households in 2022. About half or more were in the middle class.

But many workers – about one-third or more – in construction, transportation, food preparation and serving, and personal care and other services were in the lower-income tier in 2022.

About six-in-ten workers or more in education; protective and building maintenance services; office and administrative support; the armed forces; and maintenance, repair and production were in the middle class.

Depending on the industrial sector, anywhere from half to two-thirds of U.S. workers were in the middle class, and the share who are upper income or lower income varied greatly.

About a third of workers in the finance, insurance and real estate, information, and professional services sectors were in the upper-income tier in 2022. Nearly nine-in-ten workers (87%) in public administration – largely filling legislative functions and providing federal, state or local government services – were either in the middle class or the upper-income tier.

But nearly four-in-ten workers (38%) in accommodation and food services were lower income in 2022, along with three-in-ten workers in the retail trade and other services sectors.

The share of Americans who are in the middle class or in the upper- or lower-income tier differs across U.S. metropolitan areas. But a pattern emerges when it comes to which metro areas have the highest shares of people living in lower-, middle- or upper-income households. (We first adjust household incomes for differences in the cost of living across areas.)

The 10 metropolitan areas with the greatest shares of middle-income residents are small to midsize in population and are located mostly in the northern half of the U.S. About six-in-ten residents in these metro areas were in the middle class.

Several of these areas are in the so-called Rust Belt , namely, Wausau and Oshkosh-Neenah, both in Wisconsin; Grand Rapids-Wyoming, Michigan; and Lancaster, Pennsylvania. Two others – Dover and Olympia-Tumwater – include state capitals (Delaware and Washington, respectively).

In four of these areas – Bismarck, North Dakota, Ogden-Clearfield, Utah, Lancaster and Wausau – the share of residents in the upper-income tier ranged from 18% to 20%, about on par with the share nationally.

The 10 U.S. metropolitan areas with the highest shares of residents in the upper-income tier are mostly large, coastal communities. Topping the list is San Jose-Sunnyvale-Santa Clara, California, a technology-driven economy, in which 40% of the population lived in upper-income households in 2022. Other tech-focused areas on this list include San Francisco-Oakland-Hayward; Seattle-Tacoma-Bellevue; and Raleigh, North Carolina.

Bridgeport-Stamford-Norwalk, Connecticut, is a financial hub. Several areas, including Washington, D.C.-Arlington-Alexandria and Boston-Cambridge-Newton, are home to major universities, leading research facilities and the government sector.

Notably, many of these metro areas also have sizable lower-income populations. For instance, about a quarter of the populations in Bridgeport-Stamford-Norwalk; Trenton, New Jersey; Boston-Cambridge-Newton; and Santa Cruz-Watsonville, California, were in the lower-income tier in 2022.

Most of the 10 U.S. metropolitan areas with the highest shares of residents in the lower-income tier are in the Southwest, either on the southern border of Texas or in California’s Central Valley. The shares of people living in lower-income residents were largely similar across these areas, ranging from about 45% to 50%.

About 40% to 50% of residents in these metro areas were in the middle class, and only about one-in-ten or fewer lived in upper-income households.

Compared with the nation overall, the lower-income metro areas in Texas and California have disproportionately large Hispanic populations. The two metro areas in Louisiana – Monroe and Shreveport-Bossier City – have disproportionately large Black populations.

Note: For details on how this analysis was conducted,  refer to the methodology .

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June 2024 BoC: If You Ain't First, You're Last

By: Robert Both, Andrew Kelvin, Chris Whelan, Jayati Bharadwaj

First to Cut Rates

The Bank of Canada (BoC) stepped off the sidelines with a 25bps cut to 4.75% in June, becoming the first G7 central bank to cut rates nearly a year after the BoC reached its terminal rate of 5.00%. The BoC framed its decision in response to substantial progress on underlying price pressures with improvement across the BoC's preferred measures of core inflation and a return to less broad price pressures, with fewer Consumer Price Index (CPI) components seeing large price gains. The BoC did not commit to any course of action for its decision in July, but the opening statement to Governor Macklem's press conference did conditionally state that "it is reasonable to expect further cuts to our policy interest rate".

The biggest roadblock to a June rate cut (in our view) was the persistence in wage growth and signs of stronger growth momentum heading into 2024. The BoC did not sound overly concerned with wages in the June communication, noting "pressures remain but look to be moderating gradually". The BoC did note stronger domestic demand in Q1'24, but there was no mention of April's flash estimate for industry-level gross domestic product (GDP) and the BoC also stated that with the return to excess supply, "there is room for growth even as inflation continues to recede".

Core Inflation Progress Opened the Door for BoC to Cut in June

Gearing up for a gradual easing cycle.

Turning to the rest of the year, the BoC did make it clear that it expected to ease at a measured pace, as a rapid cutting cycle "could jeopardize the progress we’ve made." A gradual easing cycle is both sensible and likely, but we'd simply note that it would be unusual relative to history for the BoC to follow up the first cut of a cycle with a pause. Cuts in June and July followed by a pause in September could very easily meet the BoC's criteria for a gradual easing cycle, and as such we look for another 25bps rate cut in July. Turning to the rest of 2024, we expect that growth and inflation outlooks will have moderated by enough for the BoC to cut by an additional 50bps in Q4'24.

Return to Excess Capacity Helps Buffer Against Positive Growth Shocks

Market implications.

Rates: We look for a steeper curve for Canadian rates in the near-term. We do feel continued momentum in Canada is likely as the dovish regime is now in motion without question.

FX: We like USDCAD higher not just on Fed/BoC divergence but also from our quant model perspective. On the medium-term factors that matter including growth, inflation, carry, equity, we have seen an improvement in USD's weight and a decline in CAD's weight.

Subscribing clients can read the full report on the TD One Portal

The views or opinions expressed herein represent the personal views of the writer and do not necessarily reflect the views of TD Securities or its affiliates. This material is intended to provide commentary on the market for commodities discussed herein. Not Advice: The information contained in this material is for informational purposes only and is not intended to provide professional, investment or any other type of advice or recommendation, or to create a fiduciary relationship. Neither TD Securities (USA) LLC (“TD Securities USA”) nor any of its affiliates (collectively, “TD”) makes any representation or warranty, express or implied, regarding the accuracy, reliability, completeness, appropriateness or sufficiency for any purpose of any information included in this material. Certain information may have been provided by third-party sources and, while believed to be reliable, has not been independently verified by TD, and its accuracy or completeness acannot be guaranteed. You should not make an investment decision in reliance on this material, which is intended to provide only brief comments on the topics addressed, and is based on information that is likely to change without notice. Not Securities or Derivatives Research: This material has not been produced, reviewed or approved by TD’s securities or derivatives research departments. The views of the author may differ from others at TD, including TD securities or derivatives research analysts. Not Independent: The views expressed in this material may not be independent of the interests of TD. TD may engage in conflicting activities, including principal trading before or after posting this material, or other services involving commodities discussed in this material, or related financial products. TD may have a financial interest in the commodities discussed in this material, including, without limitation, a financial product that references such commodities. Not An Offer or Solicitation: Nothing contained in this material is, or should be construed as, an offer, a solicitation of an offer or an invitation to buy or sell any commodity, or any financial product that references such commodity, and it is not intended for distribution in any jurisdiction where such distribution would be contrary to law. Risk of Loss. Transactions in commodities, and financial instruments that reference commodities, involve risk of loss, and are subject to the risks of fluctuating prices. You should weigh potential benefits against the risks. Past performance is no indicator of future performance and the Materials are not intended to forecast or predict future events.

Robert Both Vice President and Macro Strategist, TD Securities

Robert provides research and analysis on the Canadian economy and financial markets to a wide range of commercial and institutional clients. Robert joined TD Securities in 2015.

Andrew Kelvin Head of Canadian and Global Rates Strategy, TD Securities

Andrew is the Head of Canadian and Global Rates Strategy. In this role, Andrew contributes to the group’s economic commentary and advice on G10 government debt and rates markets. Prior to joining TD Securities in 2011, Andrew spent four years working at the Bank of Canada in the International and Financial Markets Departments. With our Credit Desk Strategy team, Andrew and his team were first ranked #1 in Greenwich Canadian FI Research Quality in 2021.

Chris Whelan Director and Senior Rates Strategist, TD Securities

Chris applies quantitative and fundamental frameworks when assessing domestic and cross-market opportunities in Canadian rates across both federal and provincial bonds and swaps. Chris joined TD Securities in 2019.

Jayati Bharadwaj Global FX Strategist

Jayati Bharadwaj is a Global FX Strategist based in New York. Prior to joining TD Securities, Jayati was an FX and quant strategist at Barclays for 4 years covering G10 and EM. Her work includes thematic research and quantitative strategy to analyze financial markets, develop and back test models and tools, and provide market color. She holds a Master's in Finance from MIT Sloan and a Bachelor's in Economics from St. Stephen's College, Delhi.

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