ABSTRACT
This chapter focuses on the monetary analysis of financial derivatives. The literature considers financial derivatives virtuous securities, able to increase market liquidity and completeness on the basis of their microeconomic virtues. However, at the macroeconomic level their virtues might vanish or be dramatically darkened for numerous reasons: the adverse effects of their opaqueness; the moral hazard arising from the application of asymmetric rules; and the reduced ability of institutions to control and monitor these markets and transactions. The monetary literature has explicitly considered the role of expectations management (Galì and Gertler 2007) using both the new Keynesian and real business cycle models, but has ignored the effects and relevance that innovative financial tools, which can incorporate expectations, have on the transmission mechanism of impulses. If this special type of financial innovation is ignored, it is easy to ignore its disruptive effects as well; the subprime mortgage crisis has been an expensive wake-up call about the dangers of ignorance for institutions, policy makers and analysts. This lack of awareness is testified in the absence of comprehensive statistical data depicting the market, transaction types and conditions, and the risks involved.
