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August 16, 2006

Comments

Piyush

Can't you effectively insure against recession today by shorting or buying put options on an S&P 500 index fund given the close correlation with industrial output in recent years. And obviously some people do this.
For this insurance to be worthwhile, the prospect of a recession must not be a widespread and generally agreed view otherwise it seems to me that the premium paid for this insurance would be unacceptably high.

Jason Ruspini

I prefer my tax futures http://riskmarkets.blogspot.com/2006/08/why-we-dont-have-tax-futures.html to GDP-linked securities. The former address special interest problems and should have a strong attraction for libertarians.

Shiller notes his ideas' (especially "inequality insurance") similarity to those of John Rawls. Both have to tangle with the problem of removing "random" differences without lowering average or aggregate wealth.

Hedging is usually done to lock-in an otherwise variable spread that corresponds to some profit margin, which in turn causes wealth to accumulate. Even before transaction fees, hedging directly against an upwards drift (like GDP) is likely to result in less domestic wealth, long-term — unless the situation is quite morbid, in which case the hedge is only treating symptoms.

Andy

I believe Ghandi's comment was a response to the question (asked in the light of his advocacy of Hinduism) "What do you think of Christianity?" He meant, ironically, that it would be good if alleged Christians would actually try acting like Christians.

chris

Andy - that was the analogy I was hinting at. It would be good if so-called "free marketeers" tried to increase the scope of the market economy, rather than use free market principles as merely an ideological defence of inequality.

james higham

"... rather than use free market principles as merely an ideological defence of inequality."

Run that one by me again, for the slow on the uptake, Chris. Do you believe free market principles defend inequality and in whose favour - the weaker nations? I saw a case for this recently.

chris

James - I don't think the free market necessarily causes inequality; quite the opposite.
What worries me is that some people (like Deepak Lal) appeal to free market principles to defend inequality.
There's no inconsistency here.
Take for example the minimum wage. Free marketeers say this is bad for the low-paid, as it cuts demand for their labour. Defenders of inequality stop at this point. However, I think a better way to help the poor is to have a (high) basic income.
Free markets and redistribution are therefore consistent.

dsquared

[Retirees on fixed incomes would benefit from the lower inflation which recession often causes]

so why would they want to double up this risk by going long a security which paid off in the event of a recession but cost them money in the event of no recession?

in any case, since there already are inflation linked bonds with futures and options on them (of a sort), which work in a kindasorta way, why would someone who had an inflation risk want to hedge it through GDP or unemployment futures, at any other than ruinous premium?

Futures markets are basically insurance markets, with the insurance contract made standardised and liquid. They work for short term fluctuations where good liquidity can be established. For longer periods they don't work so well as traded instruments (look at the oil futures curve beyond the front couple of years). And when they compete with existing conventional insurance markets, they rarely do well (cf catastrophe bonds which have been the Next Big Thing for my entire career). Since there is already an unemployment insurance scheme, I don't see this market ever taking off. GDP risk is the sort of risk that is best pooled by an insurance mechanism, rather than by pretending that it can be turned into a liquid claim.

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