Risk Markets And Politics

Wednesday, December 13, 2006

Is the hedging economic purpose test ambiguous?

Apropos of Andrew Gelman's comments on the questionable benefits of betting markets, if insurance can be understood as reducing variance in wealth, consider the effect of diversification at the portfolio level. Uncorrelated assets such as those attached to political events, weather, sports or even poker hands could be used to improve the risk-adjusted returns of more typical portfolios.

Not to say that hedging, insurance and reducing variance in wealth are actually identical concepts. For one thing they are not treated the same in terms of accounting and taxation, but with some refinement this sort of idea could be useful for proponents of financial innovation in the United States.

[Cross-posted from Midas Oracle. JC Kommer later linked to a speech by Leo Melamed, in which he asserted that financial pioneering needs no economic justification. I largely agree, but offer this argument as a matter of pragmatism.]

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