What role do derivatives play in the financial crisis of 2008?

Derivatives played a significant role in the financial crisis of 2008. Many of the derivatives involved in the crisis were mortgagebacked securities (MBS) and collateralized debt obligations (CDOs), which were used to pool together large numbers of subprime mortgages and create complex investment vehicles.

These securities were sold to investors around the world, and many investors did not fully understand the risks involved. When the subprime mortgage market collapsed and homeowners began defaulting on their loans, the value of these securities plummeted, causing widespread losses throughout the financial system.

The use of derivatives, such as credit default swaps (CDS), also contributed to the crisis. CDS are essentially insurance policies that protect against default on a particular asset or bond. However, many investors bought CDS as a way to speculate on the likelihood of default, rather than as a form of insurance. This created a market for the trading of CDS, and when defaults began to occur, the market for CDS became volatile and contributed to the overall instability of the financial system.

Overall, the use of derivatives in the financial crisis of 2008 highlights the potential risks associated with these financial instruments and the importance of understanding the underlying assets and risks involved.