Academic journal article Federal Reserve Bank of New York Economic Policy Review

Macro Markets and Financial Security

Academic journal article Federal Reserve Bank of New York Economic Policy Review

Macro Markets and Financial Security

Article excerpt

Today, people have a rich set of investment options, ranging from low-risk money market instruments to high-risk growth stocks. They can choose to invest in mutual funds, hedge funds, and pension plans. They can hedge themselves with options and other derivatives while investing both at home and across the globe. Plenty of opportunities are available for diversifying their portfolios and avoiding excess exposure to sectoral or geographic risk. Nonetheless, there is good reason to believe that most people's wealth is not well diversified. For example, although investors can diversify through equity markets, corporate profits account for less than 10 percent of national income. That figure suggests that about 90 percent of an average person's income is sensitive to sectoral, occupational, and geographic uncertainty.

Shiller (1993) has proposed a new set of markets that could in theory provide much better diversification opportunities. These so-called macro markets would be large international markets trading, in the form of futures contracts, long-term claims on major components of incomes shared by a large number of people or organizations. For example, in a macro market for the United States, an investor could buy a claim on the U.S. national income and then receive, for as long as the claim is held, dividends equal to a specified fraction of U.S. national income. Such a claim is comparable to a share in a corporation, except that the dividend would equal a share of national income rather than a share of corporate profits. Such markets might exist for entire countries--the United States, Japan, and Brazil--or for regions--such as the European Union and North America. Even a market for claims on the combined incomes of the entire world could be formed. Prices would rise and fall in these markets as new information about national, regional, or global economies became available, just as prices rise and fall in the stock market as new information about corporate profits is revealed.

The potential future importance of these markets is supported by the most basic principle of finance--diversification. People could use macro markets to hedge their own national income risks and to invest in the rest of the world. This investment strategy would reduce income growth uncertainty and lead to a more secure financial future.

We address several questions in this paper. First, how could macro markets be useful to the average person? Second, how large are the potential benefits from diversification if these markets were to be introduced and used optimally? Third, can existing financial markets achieve a similar degree of diversification when used optimally? Fourth, why don't these markets already exist?


The basic idea behind macro markets is a simple one. Consider the case of claims on national income. If macro markets existed for every country of the world, people could take short positions in their country's market, thereby hedging their own country's risk, and long positions in the markets of all other countries in proportion to each country's size, thereby completely hedging themselves. The short positions in their home country would exactly offset the long positions that they hold by virtue of living there, and the long positions in the world would mean that they were completely diversified. If everyone hedged risk in this way, it would all add up, that is, for every long in every country there would be a short, and demand would equal supply in each macro market. The dividends paid on the securities for each country would be paid by the people who live in that country and hold short positions. By definition, these people can always make the payments because they are earning the national income upon which the dividends are drawn.

Taking such positions in these markets is the best way for an individual to achieve diversification. After hedging, everyone earns a share of global income. …

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