Research On The Impact Of OTC Derivatives On Economic Growth

OTC derivatives market, because of its characteristics of personalized design of contract and convenience of transaction, has developed rapidly since 1990s and become the most brilliant and important international financial market now. According to the statistics of Bank for International Settlements, the total notional amount of OTC derivatives contracts outstanding was $691 trillion at the end of June 2014, roughly 9 times as that of the ETD market on the same period.OTC derivatives market has not only huge market size, but also active financial innovation products, such as all kinds of structured products. Lacking of reasonable pricing mechanism and supervision, these complex structured products have been abused and become an important factor to the financial crisis in 2008.After the crisis, from politicians to the public, there are full of negative emotions on the OTC derivatives (especially credit derivatives). Many people doubt the function and the role of OTC derivatives, and look them as a weapon of mass destruction. So, they think the impact of OTC derivatives on economic growth is negative. Therefore, to analyze the function objectively and evaluate the influence of OTC derivatives on economic growth is a significant issue.In fact, the impact of OTC derivatives on the economy is very positive as long as they are used rationally. This thesis demonstrates the promotion of OTC derivatives on economic growth from the perspectives of enterprise value and bank loan.For non-financial companies, cash flow will wave in the daily operations because of the volatility of the exchange rate, interest rates or commodity prices, OTC derivatives can hedge these risk and stabilize the cash flow exactly, which make non-financial companies have more opportunities to grow. At the same time, using OTC derivatives can reduce not only tax expenses, but the cost and risk of corporate financial distress. Trading OTC derivatives can also cut down the main agency conflicts associated with management incentive, which is useful to enhance the firm value. And the promotion of value will be helpful to economy through the increase of investment, which can be found in traditional corporate finance theory and Tobin’s Q theory.For banks, the use of OTC derivatives can manage all kinds of risk so that they may improve the incentive of the agents, which can minimize the agency cost and enhance the function of financial intermediation effectively. At the same time, the use of derivatives also may weaken the restriction of capital to loan because banks who use OTC derivatives will be easier to raise money than the ones who don’t do that. With this money, banks will expand loans to social investment, which will promote economy significantly. Traditional financial theories all agree with that the expansion of investment will lead to the increase of total social income.The empirical study of this paper verifies the practical effect of OTC derivatives on economic growth. First, the average treatment effect of using OTC derivatives for non-financial company is to make firm value (Tobin Q) enhance 0.1246 through the propensity score method. That is to say, the effect of hedging is significant in China. Secondly, the author analyzes the influence of OTC derivatives on the scale of bank lending through the Heckman two-stage selection bias model, using the 236 banks in China as the samples. It is very significant that the results showing per unit of fluctuation of the size of OTC derivatives will promote the expansion of bank lending by 2.39%. Finally, the author estimates the cointegration besides enterprise value, bank loan and economic growth through the VEC model. The results show that per unit of fluctuation of the enterprise value will increase the GDP by 1.02% and the effect of bank loan to GDP is 80.98%. That is to say, it is very certain that the OTC derivatives can promote economic growth through expansion of bank loan and promotion of enterprise value.These results provide the basis for the further development of the OTC derivatives market in China which is still in the primary stage of development. Compared with the over innovation in foreign market, China’s OTC derivatives market is lack of development.The author puts forward recommendations from the different perspective of regulatory authorities, financial institutions and enterprises, in order to make OTC derivatives serve the real economy better and contribute more to economic growth.This thesis focuses on the impact of the OTC derivatives on economic growth, and it is divided into six chapters. The first chapter includes the background, significance and purposes of the research, and the theoretical basis and related literature review are in the second chapter, the first two chapters is an overall framework for the study. The third chapter is the overview of international OTC derivatives market, including the characteristic features of OTC derivatives and the dynamic change after the crisis in 2008. This chapter also introduces the latest development of this market in China and the comparison between Chinese and foreign market. From the fourth chapter to the fifth chapter is the core of the full thesis. The fourth chapter is a theoretical analysis, in contrast, the fifth chapter is the empirical analysis. Finally, the sixth chapter concludes the research and makes suggestions.By presenting more details, the fourth chapter analyzes the channels that OTC derivatives affect the economy from the macro perspective to micro perspective respectively, and the latter is the focus of this article. On one hand, hedging by OTC derivatives can enhance firm value, on the other hand, using OTC derivatives can increase the loan of banks. The most important is that firm value, bank loan and economic growth have a long-term balance relationship. In addition, other market participants, such as farmers, can lock in long-term gains through the OTC derivatives trading of agricultural products. Non-bank financial institutions, such as securities firms, insurance companies, fund companies, may optimize the investment combination, reduce the cost of capital and improve the return on investment through the use of OTC derivatives. All these will eventually raise social spending level so as to promote economic growth.The fifth chapter is empirical analysis which is divided into two stages:the first stage is to estimate the impact of OTC derivatives on firm value and bank lending respectively. The second stage is to estimate the co integration relationship besides firm value, bank lending and economic growth. Of course, there are other ways to affect the economy for OTC derivatives, but the empirical process of this thesis is only concerned with the influence on expansion of the bank lending and firm value.Most of the scholars at home and abroad had not distinguished " OTC " from "ETD" when they made study of derivatives before the crisis, therefore, the study of "OTC derivatives" are rare. After the crisis, the study have focused on the regulation and risk-control and neglected the impact of OTC derivatives on economic growth.In fact, OTC derivatives has become the largest and most important international financial market, its impact on the economic growth can not be ignored. In China, the OTC derivatives market has developed rapidly although it is in primary stage. This study will be helpful for micro market body to make better use of these financial tools for risk management, which will make OTC derivatives serve the real economy better.The focus of this thesis is to verify the impact of the OTC derivatives on economic growth which is a macro problem. On the basis of previous academic research results, the author uses the indirect approach, from micro perspective to macroeconomic growth, and quantified the process.The empirical process of this test is divided into two steps. The first step is to estimate the effect of company value and bank loan by using OTC derivatives. The second step is to estimate the co integration relationship besides company value, bank loan and economic growth. According to the previous literature, similar studies have rarely been done. In the process of making empirical studies, the author uses the PSM model, the Heckman two-stage model and the VEC model. Although these methods are not the innovation of author, the application on this problem is rare.Due to the innovation of OTC derivatives and the insufficient ability of the author, this study inevitably has many imperfections. First, the author is committed to a macro perspective, looking the OTC derivatives as a whole to study, so paying less attention to the differences between products. Secondly, the first stage of empirical research can only use annual data, not quarterly data because of the limitation of data sources. Furthermore, the author cannot carry out the empirical analysis of the impact of OTC derivatives on farmers and non-bank financial institutions due to lacking of data. All these are places where the author will continue to work hard in this field.