Derivative Complexity as a Key Determinant of Perceived Risk

40 Pages Posted: 5 May 2020 Last revised: 3 Sep 2021

See all articles by Michael T. Durney

Michael T. Durney

University of Iowa

Robert Libby

Cornell University - Samuel Curtis Johnson Graduate School of Management

Felipe Bastos G. Silva

University of Missouri, Columbia

Date Written: August 28, 2021

Abstract

While derivative securities are a critical component of the global economy, the complexity of derivatives is decried as a contributor to financial crises and investor losses. However, derivative complexity is not necessarily related to risk. In this paper, we use four experiments to investigate whether and why complexity is interpreted as a key risk determinant when evaluating derivatives. Our first two experiments show a robust effect consistent with investors and managers interpreting complexity as a key risk determinant and deeming more complex, but equally risky, derivatives as more risky. Our next two experiments provide evidence that the effect is driven by attribute substitution. Altogether, our results shed light on how derivatives are evaluated and suggest an important potential source of misinterpretations of disclosures provided under US GAAP (ASC 815-10-50).

Keywords: Derivative Securities; Attribute Substitution; Financial Complexity

JEL Classification: G23, M41, M48, M49

Suggested Citation

Durney, Michael Thomas and Libby, Robert and Silva, Felipe Bastos G., Derivative Complexity as a Key Determinant of Perceived Risk (August 28, 2021). Available at SSRN: https://ssrn.com/abstract=3570998 or http://dx.doi.org/10.2139/ssrn.3570998

Michael Thomas Durney (Contact Author)

University of Iowa ( email )

341 Schaeffer Hall
Iowa City, IA 52242-1097
United States

Robert Libby

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States
607-255-3348 (Phone)
607-254-4590 (Fax)

Felipe Bastos G. Silva

University of Missouri, Columbia ( email )

331 Cornell Hall
Columbia, MO 65211
United States
5738829905 (Phone)

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