Just look at this:
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Philip Sterne December 18, 2015 at 11:03
It’s a bit naughty measuring derivatives this way.
E.g. I just signed a piece of paper that says I will pay out $1.2 quadrillion dollars if Microsoft goes bankrupt in the next year. Does this mean that the infographic needs to double?
(My point being that notional values can be very disconnected from the actual value of such a contract.)Reply
Jayson December 18, 2015 at 14:19
Well yes – but surely there is something bizarre about having a notional values so vastly disconnected from the actual values of the assets in existence? You could write that contract, and then Microsoft goes bankrupt – there’s still a $1.2 quadrillion payout that’s owed.
In fact, at that degree of notional value, it might be worth everyone in the world clubbing together and driving Microsoft into bankruptcy (1.2 quadrillion between 7 billion of us is a good $170k each).
And perhaps that’s the real issue? That such perverse incentives are created by so much notional value at stake?Reply
Philip Sterne December 20, 2015 at 18:37
I suppose there are a few things that I want to reply with:
1 – I fully agree that so much derivatives can create perverse incentives. I’d be very happy if derivatives could only be issued on a fully transparent single exchange. It’d be a great first step towards better regulation.
2 – It’s not that weird that notional values are different from the actual value. Arguably the whole point of this financial engineering is to insure against unlikely events. If it’s a really expensive event then the notional value will be large, but if it’s very unlikely then the actual value could still be tiny.
3 – Trust me. Even if I had issued a contract for $1.2 quadrillion dollars and I had to pay out, you’d get far less than pennies on the dollar.
4 – Even if there was a payout of such a magnitude, it doesn’t create any new wealth. It just redistributes existing wealth and causes a lot of inflation. So there would be a lot more losers than just the fool who issued the contract (though I still pity the fool!).
Ugh – I am far too earnest when I should be getting into the Christmas spirit!Reply