Derivatives, Speculation and Economics

There is an interesting article in today's (20.07.11) NZZ on page 29 by Marc Chesney (finance professor at University of Zürich) titled "Derivative Financial Products and their Systemic Risks". He is analyzing the arguments made by economists to justify the wide dissemination of derivatives:

1. Hedging of commercial market participants: The nominal amounts of derivative instruments are nine times bigger than world GDP. Hence, derivatives are used mainly for speculation.
2. Derivatives help to increase market efficiency by enabling speculation and arbitrage: Marc argues that the increased efficiency is accompanied by increased costs of excessive speculation which drive prices higher and creating havoc on the spot market. Examples: Speculation in soft commodities driving food prices higher.
3. Aligning management with shareholder interests: Management remuneration schemes involving stock options proved to be incapable of aligning those interests when (big) losses occur. Stock options encourage excessive risk taking. 

He closes his article by pointing at the systemic risks caused by derivatives (and securitization)which were apparent in the financial crisis 2008,  and he is appealing at the academic community to reconsider and update the current financial theories.
 Interestingly, financial sector profit which were less than 10% of total corporate profits 60 years ago, and are today almost 30% of total corporate profits (see chart below). Remember that the financial sector is not producing anything and its economic function is only to intermediate capital of investors to enterprises who actually produce something.

With the introduction of modern finance (and derivatives) the financial institution managed to increase their profit margin substantially. This profit margin of 50% is double the profit margin of productive enterprises (25-30%) according to the chart below.