Folks :Could anyone give some info on how the Economic derivativesis going to take off. Will it be retail in the lines of oanda's box options ? , have you guys seen something simillar , which lets u place bets with a visa card?K

I am currently researching a project from the micro-economic viewpoint, which is similar to economic derivatives presented by DB and GS. Yes, such derivatives in case they will be openly traded on the counter and/or exchange traded it would be the new frontier in finance. The potential here is outstanding, hence, it will be possible to detect a better approximation of probability distributions, and volatility and thus having even closer form models. However, these economic derivatives are still at the infancy stage of their development. But it is fascinating no doubt!!

Hi quantie and David,I once posted the same question to General Forum, but haven't got any comments.I still don't have any idea who are willing to use this new instrument.What customer are you thinking to deal this Economic Detivatives with ?I really want to know.Monk

I'm also interested in this. Some thoughts are:1. Precedent: Inflation futures were launched, but failed to take flight. 2. Investor demand: In order for a new product to succeed there needs to be (1) an abundance of agents wanting to participate (2) with a variety of different motivations where (3) these motivations are unsatisfied by existing products. Although I can think of some circumstances in which economic derivatives might be useful, I really struggle to think of the abundance of reasons necessary to make a market successful.3. Risk management for intermediaries: This is related to Monk's hedging question on the other thread. As an intermediary I would be happy to construct a small number of bespoke structures in cases where the underlying(s) are tradeable. However, in the case where the underlying(s) are not tradeable, I would need to build a book of many positions so that my risks would start to cancel out. Considering the commercial aspects of building a business, I would be worried that I would succeed in writing a few structures, but that I would never really achieve the sort of critical mass needed to allow risks to be sufficiently diversified. i.e. I would be left with a small number of nasty unhedgeable positions that might explode in my face.In short, I believe that the precedent is bad, that investors won't care and that intermediaries will struggle to hedge themselves. It has the faint odour of over-enthusiastic MBA students after a caffeine-fueled late night! Anyone got any sunnier views?

My general reaction is that people prefer to trade things that are either objective or based on arms-length transactions. The only derivatives of interest are those that affect market prices, therefore it's usually easier to trade the price. Thus you can trade interest rates rather than inflation, a stock index rather than GDP growth and so on.There may be some exceptions. I think Treasury Inflation-linked Notes have been moderately successful because they are issued by the same government that computes the inflation number (not just the same government, but the Bureau of Labor Statistics economists are similar to the Treasury's thinkers). But for you and me to bet on a number the Australian government will compute, with all kinds of adjustments and methodological approximations and (possible) political compromises, doesn't seem to make much sense.

The pricing of these derivatives appear to be based on some auction principle . Mutualization of risk as they put it. I quote from Longitude's website:"How does a customer know what their price will be? It is important to keep in mind that a PDCA auction is a type of uniform price auction, similar to those run by the U.S. Treasury. At the end of the auction all filled orders for a given option receive the same price. This means that if the final market-clearing price of the option is less than the customer's limit price, the customer gets filled at the lower, market price - not their higher limit price. Price improvement is automatic." Longitude Inc.

The average price doesn't enter into it.All orders are limits, there are no stops. So you either input the maximum price you will pay to buy, or the minimum price you will accept to write. Of course, you can put in multiple bids with different quantities at different limits.The computer scans all the orders and picks a price P such that the total amount of buy orders with limits >= P equals the total amount of sell orders with limit prices <=P. Those buy and sell orders get executed at P. All other buy and sell orders get thrown away. I don't know how the system deals with a range of possible market clearing prices or the fact that the totals will not match exactly at any price. These details are not hard to manage.Manipulation opportunities are minor. You can certainly submit bids or offers that you think will lead other people into moving the market in your direction, then cancel them. For example, you could put in a big bid to buy a $100 when the market price is $90, hoping that will lead people to bid $95. Then you could cancel your bid and put in a offer to sell at $95. But that counts on other people being fooled. I imagine the auction monitors for this kind of thing and kick you out if you do it reguarly.If there aren't a lot of bids and offers, you can pick your level cleverly. Say you want to sell one unit and you see only four items: bids at $100 and $102 and offers at $98 and $100. If you don't bid, all four will be filled at $100. If you offer at more than $100, it will be ignored. If you offer at less than $100, you and the $98 seller will be filled at whatever price you bid (unless you bid less than $98, in which case everyone will be filled at $98). So you would bid $99.99. But this assumes no one else changes. The $100 seller might react by offering $99.98. Or someone else might come in at $99.

I believe Aaron's responding to some questions I posed and then edited out. If so, my apologies. A bit of mistiming there. I had asked about methods of manipulation in such auctions. Many thanks for your response.

The Deutsche / Goldman economic derivatives auctions have now been running since Oct 2002. Is anybody out there using them? Can they really be justified as a hedging tool or is this just punting with a respectable wrapper?Is there scope for the development of variations on this theme e.g. futures or swaps?

Can they really be justified as a hedging tool or is this just punting with a respectable wrapper?i can't seem to understand why do so many people talk about hedging with regard to development of the market ... had been following the development of steel futures on LME and again the same thing - hegders, hedgers, hedgers ... why should they matter ... no market ever develops due to hedgers ... a market has always been successful in the past because of speculators, and in the future too it will be same. there may be an initial requirement of a catalyst like market makers or a couple of participants willing to take opposite positions and then you need arbitrageurs and spreaders to blow up the volumes on low margins ... if at all there are hedgers they come 2-3 times in a year and then sit tight and hedgers are anyway not going to be there if the market is not very liquid. any new product for introduction should be designed such that speculators find it attractive, not the hedgers.

Traded the first options on short-term inflations yesterday.This really is a quantifiable hedge for pretty much any inflation position that has a little too much reset risk.initially only 1&3 month options available, but this will be extended to all options from 1-6 months.have a look at the closing prices under "Previous Auctions" at http://gm.db.com/ecoderiv

Hi, what happened if the numbers were revised? And I've checked the Longitude Site, and the PDCA is patented...I thought Parimutuel math has been existed for a long time, how can they patent this? Anyone?

in a somewhat unrelated topic, ever do/come across research to test the existence of an "implicit" inflation option on a breakeven trade of a US Tips (say the 5 year or 10 year Tips gone long versus the comparable maturity nominal)? If you look at a plot of a BEI rate versus nominal rates, then you will see that the graph resembles (to some degree) a P/L of a strangle. the 2 long options are the explicit deflation option and the implicit inflation option at the the higher rates. therefore, going long a BEI is betting on volatility in rates which is a bet on volatility in underlying inflation and growth (and in turn output gap). the premium one pays is the higher nominal rate one is paying versus lower real rate one is receiving. Notice how the volatility in BEI really spikes towards the "strike" of the inflation option - which is what one would expect near the money where gamma i believe is the highest. and how "delta" of this option as measures by Beta of change in BEI versus change in Nominal rates goes from .3 to around .7 or so around this area. This is not to say that BEI is not a bet on inflation - or deflation (in - yield region, the P/L kinks upward as well), but there is a chance that folks are underestimating this other payoff and pricing only the deflation option into the BEI rate (which is expected inflation + vol(of expected inflation)). Any ideas from the experienced out there?

a relatively unsophisticated version of econ derivatives trades for the retail side on tradesports. their version indexes economic events on a 0-100 scale, with the future settlement values indicative of whether the given contract event has occurred or has not occurred--a model obviously constructed to eliminate retail overnight risk. a trader friend suggested an interesting set of risk arb contracts along the ts lines, e.g. tender offer and election futures contracts to hedge risk arb positions. volume is relatively low, as the retail sector does not appear to have a taste for the products.

AthleteScholar - the unrevised number is ALWAYS used to validate contingent claims. If the number is revised, this impacts a totally different trading day/event. Market practitioners use Econ Derivs to hedge agst that afternoon's data release.