One of my commenters (John Salvatier) is thinking about using his own money to set up some NGDP contracts on Intrade. He sent me an email with this information, and asked for suggestions:
Each contract would be based on the BEA final estimate of NGDP for the specified quarter and the quarter two quarters before (i.e. 6 months before). The formula for the contract payout would bepayout = ln(NGDPend/NGDPstart) * periodsInYear * 1000
if payout > 100: payout = 100
if payout < 0: payout = 0.
This specification has the nice property that payout/10 = continuously compounded annual growth rate of NGDP during that period (in %). However, the drawback of this specification is that 2008q4, 2009q1 and 2009q2 would all have had negative payouts so they would have paid out 0 instead, which means you would have had trouble gauging expected the severity of the downturn.
An alternative specification ispayout = ln(NGDPend/NGDPstart) * periodsInYear * 500 + 50
if payout > 100: payout = 100
if payout < 0: payout = 0
This specification would have had positive payouts even during the most severe phase of the downturn, but it makes the contract prices more difficult to interpret and reduces the variation in contract payouts.
I would have contracts for the 6 month intervals between now and 2.5 years from now. When one contract expired, another one would be started for 2.5 years from now. I would consider using quarterly contracts instead of semi-annual contracts if people thought that was important.
I will be making markets in these contracts, ensuring a small spread. This will effectively subsidize informed traders by giving them the option to trade a little cost. I may do this manually at first, but I hope to be able to build an automated market maker to do this for me.
A few comments:
1. I strongly favor NGDP futures markets, and thus am obviously happy to see one being set up. But I fear that without government subsidies, there will be very low volume. That’s why I favor having the Fed subsidize trading in an NGDP futures market (by paying higher than market rates on the margin accounts.) Nevertheless, I greatly appreciate John’s willingness to put his money on the line.
2. I am not an expert on futures markets, so John and I would appreciate any advice on how best to set up the contracts. We’d like to make them customer friendly, but also able to provide point estimates of expected NGDP growth. And I believe John’s proposal does that. I believe there are currently some RGDP contracts that merely involve binary outcomes, such as whether growth will be higher or lower than 3%.
3. If this is set up I am going to ask all my readers to please consider trading a few contracts. The price of the contracts are pretty low (I believe $10), and since NGDP is somewhat predictable it’s unlikely you’d lose more than a few dollars on each contract. Is that too high a price to pay to show solidarity with the entire Money Illusion project? I will certainly buy some contracts. If no one trades the contracts I might just go on strike and not post for a while. 🙂
I’ll keep you posted.