Recent decades have witnessed a dramatic shift in the nature of risk in global financial markets, in which the volatility of many asset classes has increased. In an environment in which investors are continuously exposed to a broad range of dynamic risks, derivatives have become a valuable tool used in the risk management practices of institutions. As a product of developments arising from the literature, derivative markets have experienced significant growth in both the size and scope of the securities available to traders. 2 These innovations have provided users with a wide range of alternatives in managing their financial market exposures.
The consequence of derivative use is analyzed using a number of performance and risk measures we find the use of derivatives have a negligible impact on fund returns. This finding is attributed to low levels of derivative exposure relative to total fund size . We also evaluate how derivatives are used by considering the trading strategies executed by investment managers. The option trading patterns of active institutional investors are shown to be consistent with the execution of momentum trading strategies. The study also documents that active investment managers prefer to use derivatives to have risk diversification .