Thursday, January 25, 2007
Friday, January 19, 2007
I've been trying to come up with something eloquent to say about weatherbill.com, but I'm just blown away: it's just so damn cool! It embodies everything that I see as driving the future of online marketplaces. Just as intrade.com is giving economic derivatives a run for their money, I see this trend continuing with weatherbill as compared to the more buttoned down offerrings at CME.
Working at Root Markets I can't truly appreciate the perspective of soemone who is taking on a pre-existing market place and attempting to replace it with something much better. I do, however, have some theories on what it takes to succeed.
Last year I was lucky enough to spend some time with one of the founders of intrade, and I was curious to learn more about what was driving their success against the incumbet economic statistics market. The lesson was simple: you need to offer contracts that serve real needs. The message that I heard was that the payoff structure of the CME Auctions Markets were not successful in doing so. Skimming over the contract specifications and current volumes, this doesn't appear to be the case now - but it was back then. The point still remains - serve a real need - design to hedge a real risk.
Closer to home, for me, is the mortgage market. An early story that our chairman shared with me was of the evolution of the CMO market. Prior to securitization there was very thin trading in whole loans as it was commonly believed that to understand your risk exposure you needed to understand the plethora of intangible factors that could possibly drive prepayment and default risk. Buying a whole loan was thought to expose you to the risk of what side of the street the house was on, etc. Of course, with the tranche structure of the new instruments, these risks fall out leaving the holder of a CMO with exposure to the right kind of risks. Understandable systematic risks. Portfolio theory 101 at work.
As the market evolved the models improved as can be see if you compare the book for a recent issue to that of a 1980's era issue. Nowadays, with liquidity chasing liquidity, savvy investors are seeking more specialized exposure and are slicing and these tranches looking for an edge and rebundling whole loans where once the market was super thin. Specialist funds are able to do this because of the modelling power afforded by new technology. The computer I am writing this on can do a gazillion calculations per second. Thems alotta calculations.
Compare the ability to slice, dice and model on weatherbill with the handful of contracts available on the CME. If I am a small business owner, I don't want to hire someone with a degree in financial engineering to work out how to best hedge my risks. And even then, the hedge will be imperfect when there are only a limited number of contracts to choose from. Businesses want to be able to trade specialized and differentiated contracts to best approximate their risk exposure. Yes it may be difficult for an army of broker dealers to make a market in millions of contracts, but this is the sort of problems that computing power can be thrown at. If you have the right pricing models, you should be able to scale to a silly number of contracts far more cheaply than if you had to hire high rent dealers to make the market.
This sort of scalability is not afforded to all types of markets. In futures markets, where the cost of carry is infeasible, a prediction market forms. This is the case for weather, and likewise it is the case for consumer leads (my speciality). Prediction markets are special in that there is no first-order linkage between trading activity on the derivative and the current spot price. Compare this to storable goods: if the spot price today decreases, I can always buy a little more today and hold the good for use later thus changing the value of a forward contract, and vice versa. However, if it is hot today, I can't store the weather for the purpose of changing the climate in 6 months time. If the price of leads decreases today, the rapid half life of consumer attention means that a marketer will have a difficult time realizing any value from a 6 month old lead, thus leads, like weather, can't be stored.
To understand why this is relevant in determining whether a market can scale to a large number of differentiated contracts we need to look at how market makers work. If I buy a contract for a the future delivery of some good, the market maker must find some way to hedge her risk of being the counterparty to your contract. And when the volume of sales effects the spot price, liquidity risk is present. In prediction markets you don't have to balance the effect of future market activity against spot underlying values. If you have an edge in pricing future movements, you can scale with diminished exposures to liquidity risk.
In short, prediction markets are different to standard futures markets. And there is little reason to not offer highly specialized contracts to participants. Weatherbill does this very well.
By offering the ability to upload historical revenue numbers, weatherbill makes it easy for unsophisticated businesses to asses their weather exposure and to specify a contract that exactly matches those risks. It is just so easy to use and there is something, dare I say, very Web 2.0 about it all. While it is technology that empowers this, weatherbill different from, say, hedgestreet in that there is amazing simplicity to what is otherwise a complex product.
It's just so damn cool!
My bio - 8 Years ago
I found this via the way back machine. I probably wouldn't be so candid today, nor would I use the same words. Nonetheless, I wrote it, and to some extent it still rings true and is available for the world to see.
response is the output of my occupation of this media volume, related to the (con/de)struction of one dimensional signals in time. or something like that. i dont really have a purpose to this site, its just a place for me to chuck my junk so that i can access it whilst i am away from my home base. i dont like going away from home, especially if i can not take at least one of my computers with me. i guess you could say i am not very well adjusted, socially. but thats ok, this is a new dawn, and there are probably many people out there like me, similarly lacking in interpersonal skills, in place for interprocess communication. why make love when you can make a remote procedure call. what is music about really ? as far as i can tell its just a tag that people can pin on them to make them different from other people, when in reality we are all very much the same. thats why if what was traditionally an 'underground' piece of music, finds itself into the 'mainstream' - the people who originally liked the music will deny that, and claim to hate it, when they are only doing so because they have been put in the position of no longer being able to use that music to make themselves special. why do people want to be special? its alot easier to become special by developing a personality than it is to become special by becoming physically attractive, or going to the gym, or cleaning behind ones ears. thats why i dont write music any more. im not very special, you see, hence any music i produce would not help others be special - hence it would fail its ultimate purpose in our consumer society. of course music can be fun to listen to and can provide enjoyment. its easy to listen to music with lyrics and walk away with a very concrete understanding of why you feel like you do after experiencing that music. when ones moves to instrumental music, certain musical constructs have evolved amongst the genres so that people can walk away easily satisified that the music that they have heard is good. howevere for the poor sods who listen to 'experimental' music its much harder for them to justify both to themselves and more importantly to others why the music is 'good' as it may not have the same constructs such melody or rhythm that allow people to judge conventional music. too often people like this 'experimental' music because it allows people to label themselves, as listeners of this music, as intellectual/special/different/horny(?). personally i like 'experimental' music for all the previously stated reasons, but also in addition, i (as a programmer and a theoritisiticsix) i like to thing about the process that was involved in the creation of the final piece. for me creation is art. i write software as art, no specific goal, just write because it allows me to hide from reality. i have no desire to earn my living from writing software. no constraints. my software does not even have to work to satisfy my. it doesnt even have to be broken in a clever way. it just has to involve me, and thinking, because, after all, its what i do best. but no better than most people.