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Economic Derivative

What is an 'Economic Derivative'

An economic derivative is a relatively new form of derivative contract (the first ones were traded in 2002) that is based on the future value of some national economic indicator, such as non-farm payrolls, the purchasing manager's index, retail sales levels and the gross domestic product. Most of these economic derivatives are in the form of binary or "digital" options, whereby the only payout options are full payout (in the money) or nothing at all (out of the money). Other types of contracts currently traded include capped vanilla options and forwards.

Economic derivatives have become attractive for their ability to mitigate some of the market and basis risks found in standard investment vehicles.

Explaining 'Economic Derivative'

For example, a binary option trading on the GDP would pay its face value if, when the official GDP release is made (the exercise date), the GDP value falls within a specific range (strike range). If the GDP figure is outside of this range, the option expires worthless.

By looking at the implied probabilities of different outcomes, economists and investors can compare economic derivatives to Wall Street estimates and look for discrepancies between the two estimations. As might be expected, the market-driven process seen in derivatives pricing has shown itself to be the more consistently accurate predictor of future indicator release values.


Further Reading


Constructing a market, performing theory: The historical sociology of a financial derivatives exchange
www.journals.uchicago.edu [PDF]
… in the 1970s to be, in terms of the value of turnover, the largest economic activity in the … this book is that derivatives go to the heart of calculation and competition within a capitalist economy … to the operation of financial markets and per- form a role in capitalist economies in their …

Financial bubbles, real estate bubbles, derivative bubbles, and the financial and economic crisisFinancial bubbles, real estate bubbles, derivative bubbles, and the financial and economic crisis
link.springer.com [PDF]
… in the 1970s to be, in terms of the value of turnover, the largest economic activity in the … this book is that derivatives go to the heart of calculation and competition within a capitalist economy … to the operation of financial markets and per- form a role in capitalist economies in their …

Financial derivatives and the theory of moneyFinancial derivatives and the theory of money
www.tandfonline.com [PDF]
… in the 1970s to be, in terms of the value of turnover, the largest economic activity in the … this book is that derivatives go to the heart of calculation and competition within a capitalist economy … to the operation of financial markets and per- form a role in capitalist economies in their …

The economic effects of financial derivatives on corporate tax avoidanceThe economic effects of financial derivatives on corporate tax avoidance
www.sciencedirect.com [PDF]
… in the 1970s to be, in terms of the value of turnover, the largest economic activity in the … this book is that derivatives go to the heart of calculation and competition within a capitalist economy … to the operation of financial markets and per- form a role in capitalist economies in their …

Is economics performative? Option theory and the construction of derivatives marketsIs economics performative? Option theory and the construction of derivatives markets
www.cambridge.org [PDF]
… in the 1970s to be, in terms of the value of turnover, the largest economic activity in the … this book is that derivatives go to the heart of calculation and competition within a capitalist economy … to the operation of financial markets and per- form a role in capitalist economies in their …

Repressed futures: financial derivatives' theological unconsciousRepressed futures: financial derivatives' theological unconscious
www.tandfonline.com [PDF]
… in the 1970s to be, in terms of the value of turnover, the largest economic activity in the … this book is that derivatives go to the heart of calculation and competition within a capitalist economy … to the operation of financial markets and per- form a role in capitalist economies in their …

Economic geographies of financializationEconomic geographies of financialization
www.tandfonline.com [PDF]
… in the 1970s to be, in terms of the value of turnover, the largest economic activity in the … this book is that derivatives go to the heart of calculation and competition within a capitalist economy … to the operation of financial markets and per- form a role in capitalist economies in their …

The importance of the financial derivatives markets to economic development in the world's four major economiesThe importance of the financial derivatives markets to economic development in the world's four major economies
www.mdpi.com [PDF]
… in the 1970s to be, in terms of the value of turnover, the largest economic activity in the … this book is that derivatives go to the heart of calculation and competition within a capitalist economy … to the operation of financial markets and per- form a role in capitalist economies in their …



Q&A About Economic Derivative


What is an economic derivative?

An economic derivative is a relatively new form of derivative contract that is based on the future value of some national economic indicator, such as non-farm payrolls, the purchasing manager's index, retail sales levels and gross domestic product.

How do you mitigate market risks with these kinds of derivatives?

Economic derivatives have become attractive for their ability to mitigate some market risks found in standard investment vehicles. For example, a binary option trading on GDP would pay its face value if when the official GDP release is made (the exercise date), the GDP value falls within a specific range (strike range). If it does not fall within this range, then it expires worthless. By looking at implied probabilities from various outcomes, economists and investors can compare economic derivatives to Wall Street estimates and look for discrepancies between them. As might be expected, the market-driven process seen in derivatives pricing has shown itself to be more consistently accurate predictor than Wall Street estimates alone.

What kind of contracts are binary or "digital" options?

Binary or "digital" options are binary in nature where the only payout option available is full payout (in the money) or nothing at all (out of the money). Other types of contracts include capped vanilla options and forwards.

Are there different types of economic derivatives?

Yes. There are different types of contracts currently traded including capped vanilla options and forwards.

What are examples of derivatives?

Examples of derivatives include forwards, futures, options and swaps among others such as collateralized debt obligations and credit default swaps. Most derivatives are traded over-the-counter (OTC) or on exchanges such as CME Group Inc., London Stock Exchange plc or Euronext N.V.. Der

What does economic derivative mean?

An economic derivative is an instrument whose value derives from some other entity's performance. This entity can be an asset, index fund or interest rate for example.

Are there any other benefits besides mitigating risk?

Yes; they also provide insurance against adverse movements in interest rates through forward rate agreements which allow parties to fix future interest rates today based on current interest rates."