Wednesday, January 02, 2008

Bob Shiller as Financial Engineer

Economists are often surprised by the strange instruments that get attention in financial markets. Conversely, we are often disappointed that the hedging instruments we think should be important either don't exist or, when they are created, don't get as much attention as we think they deserve. (For example, like many other economists, I have long been puzzled by the absence of a large, vibrant market in inflation-adjusted annuities. I hope it develops before I retire.)

Yale economist Robert Shiller, a pioneer in financial economics, is now struggling with our meager understanding of the demand for risk avoidance. The Wall Street Journal reports that his new hedging instruments are not being eagerly received:

Other products also continue to experience trading issues, like the MacroShares oil shares that encountered trouble last year. The products were developed by Yale economist Robert Shiller to track crude-oil futures prices but have continued to trade at a wide "spread," or difference, from their underlying shares. The firm conducted a 3-for-1 stock split to try to reduce the products' share price and encourage buying.

MacroShares has also split from its partnership with Claymore Securities, dropping the Claymore name. In November, the MacroShares Oil Down product was trading at as much as an 80% premium to its net asset value, which ETF prices generally closely match, while the MacroShares Oil Up product traded at a 20% discount.

"Kill These ETFs, now" wrote Greg Newton on markets Web site Naked Shorts at the time. "The MacroShares are irretrievably broken" and "a disgrace to the ETF market."

"I think there's been some misconception about the pricing of the securities," says Mr. Shiller. He has been talking to government officials in Dubai and Norway about how the MacroShares could be appealing for hedging oil bets in their investment funds. "I've tried to get the message across, but it's been hard."