We do catastrophic financial coverage against a future market crash and nothing else. This is what we, economists, call systemic risk coverage. By definition a systemic risk can not be controlled by individual alone: it is what we call an externality. Although the society desperately needs to be provided that service no private individual or corporation can do it. An example of an externality is national defense. This ought be the role of government agencies or supranational bodies. However these organisations don't have either the will nor the knowledge to provide. Given their deficiency we take charge.Who needs it?
In theory, everybody, a systemic risk is global and everyone is concerned. Practically very few are aware of such a necessity. Everyone needs to be insured, very few buy the insurance.
We have witnessed the Great Recession. As a result we know now that a breakdown of financial market would cause a formidable disruption of what people call the real economy. A by product is that average opinion believes that the Fed can manage it. That is wrong. Indeed, the international financial community has made numerous efforts in recent years to establish such insurance, but none prevented or ameliorated the crisis that began in summer 2007. Much as we might wish otherwise,policy makers cannot reliably anticipate financial or economic shocks or the consequences of economic imbalances. Financial crises are characterised by discontinuous breaks in market pricing the timing of which, by definition, must be unanticipated - if people see them coming, then the markets arbitrage them away.
In retrospect, it will appear that the most market-savvy managers,although conscious that they are taking extraordinary risks, succumb to the concern that unless they continue to "get up and dance", as ex-Citigroup CEO Chuck Prince memorably put it, they will irretrievably lose market share. Instead, they are gambling that they can keep adding to their risky positions and still sell them out before the deluge. Most will be wrong.
Our potential customers are not concerned with market share than by the asset value of their firm. The decision to buy coverage can't betaken by corporate executive but only by boards of directors as they won't want to make a mistake in presuming that the self-interests of their organisations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms.Market target:
I made a mistake in presuming that at such a low price people self-interests was such that they would massively buy that coverage. However a necessary condition for buying such product is that the customer be aware that such risk existed. Average opinion is, like market, subject to wild mood cycles whereby periods of irrational exuberance alternate with periods of deep depressions. Depressive individuals pay unduly high insurances premia, irrationally exuberant people don't buy insurance. I came to the conclusion that, irrespective of its price, only a few people would, given the present market conditions, buy it now. Those that are most aware of such a potential dangerFuture demand:
The demand for our product depends essentially on the average expectation about the probability of the event covered rather than by its cost. Average opinion is best measured by market price. As market price change the demand for our product will change accordingly. By speculating what will be the market price, as opposed to what it is now, I went ahead of myself: market price is not governed but what I think average opinion will be, but by what average opinion expects average opinion to be.
In other words the winner of a beauty contest is not the woman I find the most beautiful but the one people think others will find the most beautiful.
Change in the demand for my product hence depends on a change in financial expectations and that, although inevitable, can take sometime.Conclusion:
In the mean time I need to concentrate on servicing the needs of those who are best able to measure the risk now, the very best speculators.
In order to serve them well, given our limited resources, I am limiting my customer base to 10. The essential issue here is double:one of insurance, with a relatively modest premium against a potentially catastrophic event, second sell to the people that are the most in need for it. The optimal way of distributing my product is through an auction.
"In one of the greatest investment markets in the world,namely, New York, the influence of speculation (in the above sense) is enormous. Even outside the field of finance, Americans are apt to be unduly interested in discovering what average opinion believes average opinion to be; and this national weakness finds its nemesis in the stock market."
John Maynard Keynes
The General Theory of Employment, Interest, and Money
Chapter 12, The State of Long-Term Expectation, VI.
Friday, December 13tn, 1935
Bidders provide their best assessment of the probability of a crash during the next four years.Rules
The insurance premium is proportional to the estimated probability of the event called the face value of the contract. It is a Dutch auction, which means that each bidder pays the bid immediately below is bid. For example, the highest bidder pay the price bid by the second highest bidder. When we reach 13 bidders the winners are the 12 highest bidders. Bid are closed. On the same auction bidders can enter as many bid as they wish. We will consider only the highest one. Bidders can bid in their name or any body they receive mandate from.
If we hold auctions at a later date bidders can enter other bids. They can hence exercise the put of their choice.
When the bidding process ends we advise the winners are granted our standard contract which they must sign electronically. No transaction can be made with any means others than our secured information system that include the emails of the no-w.com domain and the iChat account firstname.lastname@example.org.However one must be aware that no transaction made with electronic means is reputed secure, included transaction made with encryptions systems.Contract:
The owners must pay whether their exercise their options or not a annual electronic fee of €55. Payment is made in cash. That management fee must be paid at the anniversary of the contract. A contract with no assets covered and for which the electronic fee has not been paid is cancelled on its anniversary. We provide an intranet for the anonymous collaboration of the owners.
It is our intention to facilitate transactions between owner and we hope to offer a fully operational system if and when the crash occurs in order to allow our owners to continue trading when transactions otherwise will b e rendered almost impossible.
The options are bearers contract which means that they can be freely traded. By transmitting ownership of is contract the owner transmits also all the assets covered. We will provide freely a meeting place for facilitating the exchange of contracts but we take no responsibility in exchanges that might occur as a result. However we take full responsibility of any transaction between owners made trough our system whatever their size.
We will endeavour to keep the confidentiality of the owners and will never collaborate voluntarily in providing any kind of data with any enforcement agency whatever its origin. However the owners must be aware that there can be technical limits. We never store on any of our systems the identity of the owners of the contract. One of the consequence is that should the owner lose his policy contract he would irretrievably lose with it his covered assets.
Assets covered can only be assets dealt regularly on any exchange and if we can reach an agreement on their value. The assets must be quoted in a freely exchangeable currency. Assets are valued at the close of the exchange on the next trading date.
Before covering any new asset the owner must sign this contract as amended.
The assets are deposited with the vehicle of the choice of the policy owner. We pay any tax that are associated with the management of the portfolio. The portfolio can't be located in countries included in the G20 tax havens blacklist.
We manage the assets covered there is no fees other than our operating costs. The owner of the policy contract has no say on our management policy. He is informed on the operations we made one month after we performed them. He is informed of the value of his portfolio in real time.
We legally own any portfolio covered at a proportion equal to the face value of the policy contract till our management fee is fully paid for.
The winners can cover any asset they chose at any time they chose at the rate for which they won. It essentially amounts to an indefinite European put with no time value. If the rate of a future bids is higher than the bid won the option is said to be in the money.
The owner can at any time ask for the redemption of his portfolio after a deduction of a percentage equal to the value of the net gains we produced after deduction of our operating cost multiplied by the value of his contract. The value of the portfolio is marked to market. Our portfolio contains only exchange traded assets We are not liable for losses made on the value of the portfolios.Portfolio management policy:
Although we keep the discretionary right to decide on our portfolio management policy it must be known that one of its determining factor is the number of owners and the volume of assets covered. These data are our exclusive property and we will never disclose them to any outsider.
We won't discriminate among them and will do our best to manage every portfolio with the same level of care and whatever their size.
Of course when managing our portfolios we look after the collective interest of our owners no one else.
Yet the cure lies outside the operations of individuals; it may even be to the interest of individuals to aggravate the disease. I believe that the cure for these things is partly to be sought in the deliberate control of the currency and of credit by a central institution, and partly in the collection and dissemination on a great scale of data relating to the business situation…
These measures would involve Society in exercising directive intelligence through some appropriate organ of action over many of the inner intricacies of private business, yet it would leave private initiative unhindered... Devotees of Capitalism are often unduly conservative, and reject reforms in its technique, which might really strengthen and preserve it, for fear that they may prove to be first steps away from Capitalism itself.... For my part, I think that Capitalism, wisely managed, can probably be made more efficient for attaining economic ends than any alternative system yet in sight, but that in itself it is in many ways extremely objectionable. Our problem is to work out a social organization which shall be efficient as possible without offending our notions of a satisfactory way of life.
Disclosure: Long spx,Long ,Long agg,Long goog,Long gs,Long aapl,Long oil,Long gld