Subscribe to this blog's feedJason Ruspini at Risk Markets and Politics has thought of an answer to this question: what is the biggest uncovered risk category, and how would you hedge it? He suggests that the time is right for policy futures. For example, if your brewing business stands to lose from an increase in the tax on alcoholic drinks, then you should be able to hedge that risk by buying futures that will pay off if the tax goes up.
It's an interesting idea - but I can't help but be suspicious. In the example above, who takes the other side of the trade? "Speculators", says Ruspini, but that's no substitute for a naturally exposed counterparty. Who'd stand to gain from an increase in the beer duty? Apart from the treasury, of course - and I suspect that might be regarded as insider trading.
Ruspini invokes the special interest problem of concentrated benefits and diffuse costs, but it's difficult to see how a market would represent the diffuse costs well, if those who are bearing them are insufficiently interested to get involved.
But I'm open to conviction on this one. Comments? Will we soon see the end of the lobbyist and his replacement by the political futures trader?
Comments (4)
These things already exist in a number of different venues. HedgeStreet comes to mind among others.
Posted by Jerry O'Connor | May 30, 2007 5:38 PM
Posted on May 30, 2007 17:38
While when proposing new markets, "speculators" is often a pat answer when there are no obvious counter-hedgers, we know that hedge funds and others are looking for capacity, and there are many examples of possible legislative markets where there are natural counter-hedgers. In your example just replace "tax" with "subsidy" and suddenly every other tax-payer has an implied risk.
Now it is true that those dispersed interests won't suddenly coalesce when such markets are introduced, but they will be in a better situation than they were before the market was in place. Also, a large trader may end-up with a position in alignment with taxpayers' interests, which might lead to lobbying for the presumably more efficient outcome. I don't really see these markets as ending lobbying. One of their drawbacks is that they may actually increase the demand for new legislation (as opposed to hedging against bills already in the pipe). I'm comfortable discussing these potential issues though -- that's the most productive thing that can happen at this stage.
Also Jerry, there are really no public contracts like we are discussing. Intrade's social security private account contract of a couple years ago is the closest thing that comes to mind, and of course election contracts which serve the same general purpose though with vastly more basis risk.
Posted by Jason Ruspini | May 30, 2007 9:54 PM
Posted on May 30, 2007 21:54
Thanks for your thoughts. Couple of points: there's no reason to suppose that a large trader is more likely to end up aligned with taxpayers rather than in direct opposition to them, is there? And also, how exactly will still-dispersed interests be in a better position after the market is introduced, if they're still too unorganised to take advantage of it?
Posted by Alexander Campbell | May 31, 2007 5:51 PM
Posted on May 31, 2007 17:51
On the first point, yes, early-on in these markets the speculators will tend to have a position in alignment with the special interest's natural interest, but the chances of some large trader/interest adopting the dispersed interest is greater with the market in place than without.
On the second point, if I'm an individual taxpayer I don't have sit idly by while some piece of wasteful subsidy legislation goes through. I immediately have recourse in the hedging market, regardless of being able to organize against the subsidy.
Posted by Jason Ruspini | May 31, 2007 11:29 PM
Posted on May 31, 2007 23:29