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Friday, March 24, 2006

S&P Unveils Housing Indexes (via the WSJ)

I love it when financial innovation takes place. One of its biggest drivers is the desire to manage risks of various types. The general rule of financial innovation seems to be "If you can help the players manage risks, you can make money."

As one example, take the housing market. It's a multi-billion dollar industry, and the risks associated with it affect both individuals (i.e. buyers and sellers) and industry players like construction firms, architects, Home Depot, etc...

However, until recently, there was no good way to manage these risks. Now there is. According to yesterday's Wall Street Journal:
Standard & Poor's, a unit of McGraw-Hill Cos., is rolling out 10 indexes that will track housing prices in various regions of the U.S., as well as a composite index. The indexes, which plan to launch in April, will serve as the basis for futures and options contracts that will trade on the Chicago Mercantile Exchange.

The contracts will allow investors to go long or short on a specific housing market -- that is, bet on it rising or falling in value.

Dubbed the S&P/Case-Shiller Metro Area Home Price Indices, the 10 cities comprise Boston, Chicago, Denver, Las Vegas, Los Angeles, Miami, New York, San Diego, San Francisco and Washington, D.C.

Read the whole thing here (online subscription required).

The "Shiller" in the "S&P/Case-Shiller" is Robert Shiller of Yale, who is one of the biggest names in academic finance. Outside the academic world, he's known for his book "Irrational Exuberance", which called the bursting of the stock market bubble in the late 90's. In recent years he's been working on housing indexes. It's good to see his work finally coming to fruition.

According to the WSJ, the indexes will be used as the basis for contingent claims (i.e. options and futures) that will trade on the Chicago Mercantile. Given the size of the housing market and the multiple ways it affects different economic players, I predict that there'll be a huge market for these contracts.

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