Fortune Default Swap: Hedge your misfortunes away

Posted: August 27, 2010 in Crazy ideas
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10,000 words reside in the recesses of my brain, somewhere, yearning to get out and grace the world. Time, as always, is one’s best friend, but one whose company I seldom seem to enjoy for long. The serious (and boring) writing is out on hold to make way for momentary craziness, a fuel that’s necessary for mankind’s survival.

I overheard a girl whining away to a friend in the tube (okay, I eavesdropped. That’s the most productive thing to do when your mouth and brain are inactive). The object of the whining was her apparent misfortune. While she did not elaborate on the causes, I suspect it was love that was the omnipresent protagonist. But we won’t get there. I liked the misfortune bit; as it happened to be the inspiration behind an idea that makes up this post. Needless to add, I dutifully stopped eavesdropping once I set off in my chain of thought…

I thought of the very many people around me who somehow seem oversold on their own misfortune and their neighbour’s good fortune. I include myself in this category. Aggregate this to a sample population and what we have doesn’t appear a zero-sum game. The collective misfortunes seem to be outweigh the good bit several times over. Well, of course something’s amiss somewhere, but then, wth, I’m eyeball deep in my beliefs to worry about zero-sum games with Lady Luck.

What is a Credit Default Swap? Do I digress? Not quite. A Credit Default Swap, or CDS for short, allows a buyer to insure himself against a bond issuer’s default. In simple terms, a CDS buyer makes a series of cash payments to a CDS seller, much like a life insurance contract, in return for a promised juicy payout should a bond issuer default on its debt. To make the idea simpler, a CDS basically protects the buyer against a slew of possible misfortunes that might strike the issuer of a bond over a period of time.

A Fortune Default Swap (FDS) would work similarly. An FDS buyer would make a stream of cash payments to the seller in return for a promised payout in the event of sudden and unannounced misfortune strikes. Misfortune could be defined to include numerous things. When I look around, the number of items that could be included under the misfortune category number in the hundreds, if not more. But this could be handled with some tweaks.

Who could be interested in an FDS? Since I seem to be convinced that my neighbour’s fortunes are perfectly inversely related to my own, I could be interested in an FDS contract. I must add that the inverse relationship seems to hold only for my misfortunes and not for my good ones (there never seems to be enough of the good variety, and there seems to be even less of ill fortune inflicting others).

I would consider buying an FDS and making a stream of payments to a willing seller, in return for a lump sum payout in the event misfortune were to strike….me! I would be the object of misfortune and once I enter into an FDS contract, I would have effectively hedged my misfortunes away! Now, if misfortune were to strike, I would be happy because the FDS payout would protect me. The FDS would turn misfortunes into boons. Once I purchase an FDS, I would look forward to bouts of personal misfortune…the more the merrier.

Since my neighbour seems to view the fortune/misfortune relationship much the same way as me, he would enter into an FDS to protect himself. And given the fortune/misfortune relationship, I would be the seller for this contract. I do so because I believe my misfortunes would outnumber my neighbour’s, leading to greater cash inflows for me over a period. My neighbour, in turn, becomes the seller on the FDS contract that I buy on myself, since he believes……

So we have 2 FDS contracts; one, in which I am the buyer and another, in which I am the seller. Since my neighbour and I would be making a stream of payments to one other, the contracts could be priced such that there’s effectively no net payments to assume the other’s misfortune risk. Now only misfortune-triggered blow-ups would lead to cash flowing from one side to another. I would happily enter into such an arrangement because I’m convinced I would end up with a net cash inflow.

The FDS idea would help me pass on my personal misfortune risk. It would allow me to be fortune neutral. If I was lucky enough to have a run of good fortune, the happiness that I derive from this would dwarf the cash payments I make on my FDS contract. In the event of a run of misfortunes, the cash payouts from the FDS contract would somewhat assuage my busted happiness. The product would have an additional hidden benefit. By monitoring money flows, it would be possible to put the theory of my misfortune/neighbour’s good fortunes to test. The fortune/misfortune relationship could be quantified meaningfully for the first time ever.

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Comments
  1. Ram says:

    The reader is great. On a lighter note, and not really intending to make fun of your ‘misfortune’, our own society has institutionalized FDS ages ago. The term is however marriage. It starts off as an insurance with tangible/intangible promises, but with time, misery is exchanged.

    On another note, you made a passing mention on Game Theory. Which inspired me to look at the situation through the prism of the prisoners dilemma and its characteristics of co-operating and defecting. I leave it to your imagination on how the FDS can be manipulated there.

    Look forward to reading more such stuff.

    • Thanks for the comment. Marriage is a good example, albeit a funny one! Except that the men, apparently, seem to pay out more than their fair share over time. The women are smarter here.

  2. […] of gargantuan proportions, we could introduce another instrument suggested by yours truly earlier. Fortune Default Swap: Hedge Your Misfortunes Away, that is designed to safeguard against attacks of […]

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