Euro Crisis: Financial Derivatives Analysis and Prediction

Although Greece has proposed a new fiscal policy in order to reduce the deficit to reach the EU's requirement for assistance, the market seems to be not optimistic about the overall economic outlook for the euro area as rating agencies Fitch and Moody's gave negative feedback to the United Kingdom and Portugal. The investors' worry about euro and euro zone began to heat up again.

Leading to intensified European countries sovereign debt crisis was the fact that there were significant differences between euro area economic development of countries but they had to accept a unified monetary policy arrangements, resulting in the economic crisis, economic difficulties in the countries that cannot alone respond to crisis. The soaring of the credit default swap rating in the euro-zone countries sovereign debt crises shows in-depth development of euro crisis. It is such a tool that is widely criticized by the European countries because it is the inappropriate use of it deepened the impact of sovereign debt crises, and even to some extent acted as an important facilitator of the crisis.

European countries' dissatisfaction to credit default swaps is not without reason. Similar to insurance contracts as a type of financial derivatives, credit default swaps contracts give to the buyer the reassurance that if the underlying debt default occurs, the seller from the contract can acquire the right to full compensation. As the derivative financial instruments have been gradually widely used by, including banks, large financial institutions, credit default swap market also appeared in recent years, with rapid expansion. Seven years ago, there were less than 3 thousand billion dollars and now it the market quickly expands to the size of more than 25 thousand billion U.S. dollars, while a large part of which the holder uses not to hedge risks, but uses as a tool for speculative gain.

Financial derivatives are difficult to be effectively monitored and supervised by financial institutions in times of crisis. Regulators will be difficult to understand their potential role and the specific size. The real risks result miscarriage of justice and delay the most excellent time for crisis management. For this reason, in the collapse of Lehman Brothers, AIG and other financial crises of the major events of bankruptcy, the credit default swaps have played an extremely important role. We can say they fueled the development of the financial crisis. And investors have generally agreed that European countries sovereign debt crises and the improper use of this tool have a very close relationship. Some financial institutions through the creating of investors' anxieties of Greece and other European countries' fiscal deficit and sovereign debt risk, have pushed up borrowing costs of financing in these countries and raised the credit default swaps interest rate to derive significant benefits from them.

Many European countries, in order to weaken the influence of financial instruments, are currently promoting a reform, which prohibits the speculators into the credit default swap market, while allowing only those who hold the hands of sovereign debt through credit default swaps to hedge the risk of financial institutions defaults. The United States, although not clear on this issue, is showing Obama administration's efforts to promote transparency in derivatives market direction. So U.S. is also moving in that direction.

The effectiveness of this reform at present is hard to have a clear conclusion. Many are concerned that in the market for credit default swaps market, the excessive restrictions may affect the capacity of financial institutions transfer the overall risk of the financial system, thus raising the cost of sovereign debt borrowing for the future. So restrictions have a negative impact on future financial market developments.

In Greece, Italy, Portugal and other countries of the credit default swap rate sees a clear rise, which to some extent is relevant to these countries' effort to reform. The derivative financial products in the burgeoning market have been growing for nearly 10 years. Now they seem to have encountered numerous obstacles. How the future of this market will evolve will have a very significant impact for the entire financial system.