Which Investor Group Services Cause Negative Externalities?

Investor group services are designed to provide benefits for investors and have a positive effect on economic activity. However, there are some activities that investor groups engage that may have a negative effect on the economy and lead to financial calamity or failure of the system.

Negative Externality

An externality is defined as cost or benefit that is associated with an economic activity. Buying stocks ahead of the public based on insider knowledge has the affect of providing a benefit to the insider at a cost to the public investor who does not have access to such information. An externalities can be positive or negative, but when negative, it produces a ripple effect throughout the economy that threatens the stability of the financial system.

Addressing Negative Externalities

Such services as derivative trading, where the risk of an unknown security is not priced properly or understood, can cause systemic risk in the financial markets. A way to ameliorate negative externalities that have the affect of damaging or eroding confidence in the markets is through regulation. A strong regulatory community, even in free markets, has a chill effect on reckless behavior and installs controls necessary to protect the interests of everyone, not just the few.

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