The impact of payday loans market
There is mixed evidence on the impact of a derivatives market on its underlying asset market. Some studies have found a reduction in volatility after the introduction of derivatives while others conclude that volatility was not affected or even increased.
The general reasoning for an increase in payday loans volatility states that derivatives attract speculators who may destabilize the base market and create bubbles, and that the closing out of hedging positions shortly before expiration creates additional price variation. On the other hand, a decrease of volatility could result as derivatives make a market more complete, reduce transaction costs and enhance information flows. Also, the transfer of speculative activity from the base market to the derivative market may dampen volatility.
Others suggests that derivatives improve the efficiency of incomplete markets by expanding the opportunity set faced by investors. This in turn should reduce the volatility of the underlying asset. Research show that option listings have beneficial effects and improve the market quality and liquidity of the underlying stocks. They analyzed the impact of derivatives on their underlying assets for 174 stocks that had an option listed on either the American Stock Exchange (Amex), the Chicago Board Options Exchange (CBOE), the New York Stock Exchange (NYSE), the Pacific Stock Exchange (PSE) or the Philadelphia Stock Exchange (PHLX) from 1983 to 1989. In particular, they observed a decrease in the bid-offer spreads and increases in quoted depth, trading volume, trading frequency and transaction size after the introduction of derivatives. In summary, the listing of options resulted in reduced transaction costs for the underlying stocks. Further, they found that information asymmetries decreased and pricing efficiency increased.
Payday loans to build exposures to different markets
Throughout the 1990s, several other initiatives were launched to get derivatives started. Iain Reid, a property consultant, realized that property funds could benefit hugely from the ability not just to build synthetic exposures to different segments of the market but also to hedge existing long positions by creating off-setting short positions. Reid moved to Barclays and found that its bankers were similarly enthusiastic about his plans to develop a product that could hedge property exposures. The UK real estate market had just been through a crash, and Barclays had property exposure as a result of bad loans made to property developers. To them, the idea that they could hedge that exposure was a revelation and they were very keen to launch something.
Together with Aberdeen Property Investors, Barclays Capital structured a tradable bond that pays out IPD index returns. They called these bonds Property Index Certificates (PICs). PICs link their coupon payments to the IPD All Property Income Return Index and the capital redemption value to the IPD All Property Capital Growth Index. Investors who wanted to gain exposure to the property market paid upfront to buy the bond and received income based on property valuations in the form of quarterly coupon and redemption payments. By issuing PICs, Barclays basically exchanged its long property exposure for a fixed income. The PICs were seen as bond instruments that pay a return based on an IPD index rather than pure derivatives.
The instruments enable investors to bet on the market, but not against it. Since its release, the certificate has mainly created interest from high-net-worth, private bank and institutional investors. In addition, Barclays launched exchange-traded Property Index Forwards (PIFs). These forward contracts on the IPD Capital Growth or Total Return Index included some standardized elements, to make the products tradable. However, in contrast to exchange-traded future contracts, not the market itself but the bank took the role of the market maker. Since the bank never really succeeded in developing a liquid secondary market, the concept was still based on matching buyers and sellers. Barclays continuously quoted prices for the contracts.
Cash-settled payday loan contracts are available
After the launch of futures and options on regional home prices, CME announced a partnership with the commercial real estate index provider Global Real Analytics (GRA) on 6 September 2006. They listed future and option contracts based on the S&P/GRA Commercial Real Estate Indices (CREX) on 29 October 2007.
The S&P/GRA CREX indices capture underlying real estate dynamics by tracking transaction-based price changes in diverse property sectors and geographic regions. GRA has a 20-year history of capturing data and sees the new indices as a natural extension, suited for the use of publicly traded futures contracts.
Ten quarterly cash-settled contracts are available: a national composite index, five regional indices (Desert Mountain West, Mid-Atlantic South, Northeast, Midwest and Pacific West) and four national property type indices (retail, office, apartment and warehouse properties).
CME expects the users of the new property contracts to be different from those trading in housing derivatives. If someone hedges against house-price declines in an area, he or she develops or buys a house there. The commercial contracts, on the other hand, are designed for larger investors who hold commercial properties in their portfolios, such as pension funds and REITs.
To hedge real estate or home price declines, individuals can purchase put options based on a particular index. If prices fall, investors will naturally see the value of their real estate holdings decline, but they offset the losses with gains in the put options. The CME hopes that there will be enough speculators in the market to take the other side of the transactions.
Market participants report loan enquiries
The first French property swap was traded by Merrill Lynch and AXA Real Estate Investment Managers in December 2006. The undisclosed notional amount was linked to the IPD Total Return French Offices Annual Index. By mid 2007, the French market has developed a permanent two-way pricing, i.e. bid and offer prices are constantly quoted. By the end of the fourth quarter of 2007, GB£ 787 million have been transacted in 63 trades. Most trades have been done on the office component of the French IPD index.
Moreover, market participants report enquiries on derivatives relating to the National Institute for Statistics and Economic Studies (INSEE) residential house price index.
The first option on an IPD index outside the UK was traded in January 2007, referenced to the German IPD/DIX Index. Goldman Sachs acted as intermediary for this trade, which was one of the first property derivative transactions in Germany. Subsequently, BNP Paribas offered a capital protected note on a basket consisting of IPD UK All Properties, IPD France Offices and IPD Germany All Properties. IPD publishes official transaction data starting with the second quarter of 2007.
The market picked up quickly, with 44 trades on a total notional value of GB£ 283 million from the second to the fourth quarter of 2007. In May 2007, Deutsche Bank Research expects the German market to reach € 25 billion by 2010. HypoVereinsbank states that a volume of € 150 billion is possible in the long run for Germany and € 300 billion for the European Union.
The numbers represent about 1% of the respective physical property market.
Relative payday loans demand
The International Securities Exchange (ISE) launched a derivatives market based on the Rexx commercial real estate property indices in November 2006. The market will operate using the Longitude framework, a matching engine based on a Dutch auction process.
At the launch, a subset of the Rexx indices was chosen based on anticipated demand. For each index offered, a series of auctions was held prior to publishing the Rexx index, which allows market participants to trade digital and vanilla options as well as forward contracts on the index value.
The auction format differs from a traditional, continuously quoted market in several ways. Instead of requiring a discrete match between a buyer and a seller, the auction aggregates liquidity across all strikes and derivatives. The prices in the auction are determined by the relative demand represented by all the orders received up to that point. As the auction operates as a Dutch auction, all trades are cleared at the final auction market price, even if that market price is better than a trade’s limit price. According to ISE, auction participants include pension funds, commercial property managers, investment banks, hedge funds, portfolio managers, REITs and CMBS. Besides serving as an underlying part for the ISE platform, the Rexx index is also said to be used in the OTC market.
