Emerging derivatives markets: The case of Chile

Despite impressive growth in derivatives markets around the world, there is considerable heterogeneity in the degree of development across countries. In Latin America, derivatives markets in Chile lag far behind those in Brazil and Argentina. What accounts for these differences? The analytical pricing machinery of Black and Scholes (1973), as well as the voluminous literature on contingent claims that has developed since, is freely available, so the answer probably lies in institutional and legal factors. We discuss different institutional aspects of derivatives markets in Chile and simulate the potential benefit for hedgers of using these instruments. Specifically, under different scenarios, most currency risk may be reduced by rolling-the-hedge strategies involving Chilean peso-U.S. dollar (CLP/USD) forwards. In our view, low liquidity of spot markets, high trading costs, and stringent regulations governing institutional investors - in particular, pension funds - appear to be driving factors in the thinness of the domestic derivatives market.