Mechanisms for Hedging Long Streams of Income
Most people are interested in hedging risk of claims on long‐term income flows, rather than on the risk of the next month's or next year's income, and this means that any market that allows hedgers to protect themselves from information that is adverse to their income over the indefinite future must be a market in the present value (capital value) of this income stream, not a conventional futures or options market in the income itself. This chapter considers two ways in which such new markets, where the information about income flows is so intangible, could be created. One way is to create a sort of derivative market, based on an index of observed prices in other (relatively illiquid) markets for claims on the same income stream (settlement based on cash‐market asset price). Liquid markets in residential real estate might be set up this way (this example is pursued in the chapter), and such a method of insuring against adverse information is analogous to that used to provide fire insurance, where the income stream is the flow of rents (or imputed rents) on the property, and the maximum insurance is the present value of this stream inferred from the sale prices of comparable properties. The other way is to create a market for perpetual, or at least long‐horizon, claims on an income flow itself, making no use of prices of claims on the flow in any other market; the income flow can be a theoretical construct of statisticians, not the dividend on any tradable asset, and liquid markets in national incomes might be set up in this way (settlement based on measures of income rather then price, achieved either through perpetual claims or perpetual futures markets).
Keywords: claims on an income flow, derivative market, futures markets, hedging, hedging income streams, income streams, Liquid markets, macro markets, new markets, perpetual claims, perpetual futures, risk management
Oxford Scholarship Online requires a subscription or purchase to access the full text of books within the service. Public users can however freely search the site and view the abstracts and keywords for each book and chapter.
If you think you should have access to this title, please contact your librarian.