Risk Markets And Politics

Friday, April 28, 2006

Economic Derivatives Observations

One small bone to pick with yesterday's CME Economic Derivatives reception: Gartman and others perhaps overstated the hedging utility of these auctions. After all, how many traders have exposure to economic releases as such? They probably have fixed income, currency or equity positions and there are already plenty of ways to hedge these. While the economic derivative markets were repeatedly billed as a way to hedge risk "more precisely", it seems that they actually provide traders a hedge with more basis risk, and, more precisely, open-up a new avenue of speculation. One can guess why so much emphasis was put on hedgers, as their image gives the fledgling markets a robust glow and implicitly beckons to speculators. In terms of reducing systemic risk, the fact that the auctions reveal the distribution of expectations might be as important as their use in hedging. Insofar as they are used to hedge against surprises, one might expect the tails to be overbought as is typical for parimutuel auctions, but the degree of this tendency is still unclear.

Now, in a way, ignoring measurement and Goodhart's Law-esque issues, economic derivatives certainly are more precise, and address risks captured only roughly by more established markets. These risks are the sort that develop over time though and might be better served (at least in terms of certain grand visions of risk-sharing) by standing markets as opposed to sporadic auctions on "noisy" releases that are only open to institutions.

It was actually surprising that Dennis Gartman brought-up the IEM election markets. More exciting, he spontaneously asked a representative from the investment bank most closely associated with the auctions if they might extend the infrastructure to political events. While this wasn't ruled out, frequent events with more direct economic relevance were stressed in response. An equity earnings release auction was cited as a possibility.

Interest in earnings release markets was predicted here at the beginning of the year, with the caveat that these numbers are heavily managed and that they are rather easily skewed by a penny or two. Earlier in the week, Victor Niederhoffer described a typically enlightening little study on just this point. The sample of earnings surprises was nothing like a normal distribution, and was quite suspicious in terms of the asymmetry between small upside and downside surprises. Earnings release markets would operate in light of such irregularities.

One can't help but notice that tax and subsidy related markets can be described as political, economically relevant and reasonably frequent. In spite of the arguments in favor of such markets, they would inevitably be somewhat controversial. Perhaps it will take an organization with a certain amount of gravitas to forge ahead in that area, especially in the United States.

3 Comments:

  • Won't TradeSports as an eventual exempt board of trade possibly have a political market for institutional investors at some point in the future?

    By Anonymous Anonymous, at 9:48 PM  

  • As the months tick by, it's more enlightening to watch what these companies (e.g. Intrade, Hedgestreet) actually do as opposed to what they say. Clearly, everyone wants to host institutional trading and will talk-up this point given any opportunity.

    My guess is that Hedgestreet has the upper hand here, at least in the US. This opinion is partially based on their alliance with the CBOE. Although, regarding that alliance, the meaning of the subsequently announced CBOE real estate futures is unclear. Are these going to be replace the smaller Hedgestreet contracts, which are also based on NAR data? (Hedgestreet apparently pulled their housing futures this week until further notice.) Or does this indicate a weakening of the alliance? Or maybe the products will trade simultaneously, which might encourage market-making on the Hedgestreet side?

    By Blogger Jason Ruspini, at 8:29 PM  

  • Do you have any other articles or info on credit derivatives pricing or trading? I found some interesting information on the following sites:

    http://www.axiomglobal.com

    http://cdsaxiom.com

    By Blogger fancy smancy, at 10:59 AM  

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