After reading this Bloomberg column, author Mark Buchanan, I should have severe doubts. I have read the reference article by MIT economist Alp Simsek, but not being a macroeconomists, I need concentrate on the conclusions.
And I take them from the column. Derivatives do not make markets safer will be agreed by the Main Street, but not Wall Street (synonymous for real economy and financial markets). Are they ever going to love each other.?
I know enough about macro that the "imbalance" of investments in things that can produce income and those in existing assets (wealth) can do harm to an overall economy. Some say, real vs speculative.
And yes, some of the derivatives are combined with such speculative investments and helped fueling bubbles (the CDOs and the housing bubble). Interestingly enough, if you look deeper into the maths of such instruments, you see it with your eyes (correlations that can only come from tea leaf reading, or time dependence is not modeled, ....).
But one of the reasons for the bust after the boom was: market participants did not understand that mortgage based securities contain a convex risk of a put option.
We also know now that diversification does not always work - My view here.
One of the conclusions of the original paper, in short: the effect of innovation on portfolio risk in a standard mean-variance setting with belief disagreements may be negative - by increasing average portfolio risk. IMO, this may be true if portfolios are directed to more speculative assets in the above sense.
But in general it seems that such analysis is restricted to the view: risk is cost (Markowitz' view) and not seeking optimal risk?
This is why I like Aaron Brown's book Red Blooded Risk. It is also about the co-evolution of the innovativeness of the real economy and financial markets. Not naively, ... Rusk is not identical with danger. And simulation can help to unmask the influence of belief disagreements.
