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Monday, March 21, 2005

Schiller on Managing Risk

Patri Friedman at Cattalarchy provides some excerpts from a recent speech by Robert Schiller.

Schiller mentioned several new possibilities for managing risk, including:

  • Home Equity Insurance: The big monetary risk of a home nowadays is not fire, it is market movements. Shiller has founded a fund to offer securities that can be used to protect against home equity risk.
  • Country Income Indices: Why not sell your country short, and buy the world, in order to reduce your country-associated financial risks?
  • Longevity bonds: (whose payoff depend on the longevity of a large demographic group) to hedge against age-distribution-related risks.
Click here for the whole article.

When I teach financial markets, one of the unifying themes use is that new financial instruments are constantly being developed as a way of pricing, managing, and shifting risk. In addition, we talk about how the process of financial engineering has accelerated in recent years due to the increased availability of cheap computing power (I'm currently typing this on a $1200 laptop that would have exceeded the computing power of the typical mainframe in 1990). This has dramatically lowered the cost of (and increases the spread) of computationally intensive models.

Click here for a related post on how this has even change baseball.

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