>they begin to distort the value and prices of the underlying securities. In the real world
I disagree. I don't believe the problem was price distortion. Instead, it was caused by there being no means of seeing counter-parties to most of these transactions, and hence no way to measure (and hedge) the risk.
If I'm going into a deal with AIG, I have no way of knowing what other deals AIG had done, and hence no way to put an accurate price on their default risk.
If there was a "derivative" clearing house, most of the problems go away.
I disagree. I don't believe the problem was price distortion. Instead, it was caused by there being no means of seeing counter-parties to most of these transactions, and hence no way to measure (and hedge) the risk.
If I'm going into a deal with AIG, I have no way of knowing what other deals AIG had done, and hence no way to put an accurate price on their default risk.
If there was a "derivative" clearing house, most of the problems go away.