Rambling post: risk management, asset securitisation etc

I was watching a show on TV where they were talking about how well-off but not devastatingly rich people can now fly in private jets and avail of exotic holidays because of the availability of time-sharing schemes. The ideas weren't new to me but then the show surprised me: time-sharing for supercars?

It seems a certain company (in the UK?) now allows the affluent to lay their hands on a vast fleet of top-of-the-line cars for a yearly fee. You're allowed to drive these beauties for a certain number of hours every year. Time-sharing for cars then.

Then I watched quite a different show on a different channel. This one was about grid computing. About how "utility computing" would transform the way businesses thought about and used their IT infrastructure. This isn't time-sharing, of course; it's pay-as-you-go.

The time-sharing schemes are essentially call options. Utility computing efforts are even simpler financial instruments. The focus is on maximising utilisation levels and constantly increasing efficiencies. They're essentially operating leases.

These are some of the reasons why finance (and, to an extent, economics) interests me so much. The efficient allocation of resources. Minimisation of transaction costs and transaction sizes, and the corresponding growth in markets that comes about as a result.

Perhaps the best known example of the real benefits that finance can bring to everyday life is mortgages. Or rather, mortgage-backed securities. (Michael Lewis' book Liar's Poker is perhaps the most fun and entertaining introduction to MBS's.) The liquidity that MBS's brought into the market created value for all market participants -- even those who were not actively participating in it, such as homeowners.

But you probably know all this already. The reason I started writing this post was that it occured to me that advances in technology, advances in mathematical/analytical techniques, the ability to target & analyse individual customers and the sheer diversity of players in financial services (it's not just banks anymore as the examples above illustrate; it's also IT firms and holiday companies) can only serve to accelerate the types and number of financial innovations in the market.

A tiny seed of an idea has been germinating in my head for the past month or so about how similar innovations will soon make themselves apparent in risk management (as opposed to consumption of goods or making investments). And again, I don't mean risk management in the purely financial sense of hedging against currency risk and things like that. I mean risk management in the sense of, say, a guaranteed quality of service provided by a firm to its client. Clients sometimes need more than just the plain vanilla service at the lowest price; they may need an ironclad guarantee that it will work as promised, and they will be willing to pay for it. (Sorry, I know this all sounds abstract/vague/lightweight but I did say it was only a germ of an idea!)

For instance, how about risk management for consumers? Perhaps the only area where this is developed to a degree of sophistication is in insurance. Even there, I'm not sure that consumers are not overpaying. And apart from the price, not everything I want covered is covered. I can't design a custom policy for myself.

I will share with you in a separate post how I got started thinking about risk management. As a matter of fact, it was because of an article I was reading about a technology company that has started using risk management techniques in its procurement processes. ("How cool is that!" thought the geek.) This post is only meant to be an introduction and a way for me to define my own thought process.

If this random, rambling post has made any sense to you :-), I'd like to know what your views are on risk management's broadening scope and the opportunities this presents. Send me an email or leave a comment. Or post on your blog and TrackBack.

Comments

[svk]

I heard Myron Scholes talk last year and he described Risk Management as still in the "embryonic stage" of development.

Take a look at www.hedgestreet.com this is risk management for individuals. Think about having the ability to be short real estate or long inflation in the purest sense of it.

Also you said "The time-sharing schemes are essentially call options". Can you elaborate a bit more on this?

[Murli]

Thanks, svk -- and sorry for this astoundingly late response.. I haven't posted much recently and somehow I missed the comment notification I should have received by email.

Your comment about what Myron Scholes said is very interesting -- do you happen to know where I can find a transcript/summary of his speech? Or any articles he's written specifically on this subject?

Also thanks for the link to HedgeStreet -- maybe I'll start trading there. I used to trade forex and it was great fun.

About my comment on time-sharing schemes: you got me -- that was loose usage of the word option. But now that I think about it, it does resemble an option in that, once you pay your fee to the time-sharing scheme, you have the choice (option) to avail of the holiday facilities offered by the scheme. If you don't avail of it within the prescribed period, the option lapses. [Does that sound lame? Sounds like an option to me! :-)]

So the fee you pay to buy the time-share is the option premium and the exercise period is the time in which the timeshare owner is allowed to use the property. (Any ideas on what the the exercise price is? Zero?)

There are even schemes that allow trading (exchange or buy/sell) of timeshares, as you probably know.