Thursday, September 11, 2008

Betting on doomsday

We've already looked at Long or Short Capital's End of the World puts for the start-up of the Large Hadron Collider (based on their proprietary Black-Holes algorithms).
Here's the Financial Times' Lex column on one effect of the GSE bailout:

Friday the 13th in April 2029 could be a real nightmare, though the odds are slim. According to Nasa, the chances of an asteroid packing the power of 65,000 Hiroshima bombs striking the Earth are 0.3 per cent. What if someone were to insure against loss of life and property? Only a fool would buy it, however low the cost, unless the underwriter happened to be headquartered on Venus.

But the financial markets have cooked up a product that seems almost as unnecessary – credit default swaps against a US sovereign default. Following the takeover of Fannie Mae and Freddie Mac, the cost of protection hit a record high according to CMA Datavision. A 10-year contract was offered at 23 basis points annually. By contrast, protection against Argentina defaulting would cost 872 basis points. Unlike other CDS contracts, the US product settles in euros, for obvious reasons.

Aside from the argument that a US default would likely vaporise whatever bank pocketed the premium, the risk is not quite as far-fetched as it seems....MORE