January 12, 2007

The Pie of Derivatives

by PG

I think I need to sit down and read a book about derivatives, because I find them intensely confusing, particularly as they become more abstract. (To that extent, I'm in sympathy with the citizens of Ankh Morpork who constructed a warehouse for pork futures.) I've understood selling short since high school, when our one-semester government/ economics class -- in which the total economics we learned was Reaganomics and basics about the stock market -- and since I disentangled hedging from hedge funds, both concepts have been easier to grasp.

But financial instruments like weather derivatives confuse me utterly. For one thing, they seem like a zero-sum game, and I hate aspects of the economy that are zero-sum games; I idealize capitalism's ability to connect people for transactions that are profitable to them both, whether it is buying and selling labor, goods or insurance. Weather derivatives seem comprehensible to me only if I think of them as the kind of risk-pooling we get in standard insurance, where many people pay fees to be protected against the cost if an individually- unlikely- but- inevitable- over- a- large- population disaster occurs. On a one-to-one basis, they seem to make a winner and a loser based on whether the event occurs.

January 12, 2007 1:28 AM | TrackBack
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