Garett Jones  

How to bet on bad futures

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Some people think the world will end this year, some think the US is bound to default or inflate its way out of debt, some suspect the Singularity will end in a John Connor scenario.  

How can these prophets of doom cash in on their confidence?  After all, they think that the state of the world where they're proven right is a state of the world where nobody can reward them for being right.  Aside from the self-congratulation, how can they benefit?

By signing a contract right now.  If you're reasonably sure Treasuries will be worthless in a dozen years, you should find somebody who disagrees, and convince them to give you $1 today.  If you're right, then 12 years later you get to keep the money.  If you're wrong, you have to pay the other party the normal rate of return on the $1, plus a little extra. $2 should be plenty if you can back the contract with some collateral; maybe $4 otherwise.  

Notice what you're doing here: You're writing an uninsurance policy.  You get the premiums up front, and you pay out only if things turn out fine.  Since the other party is pretty sure things will turn out fine, the deal you're offering from their point of view is about the same as any other investment.  That's why you only have to offer about the normal rate of return.  

The hard part here, of course, is convincing the other party you'll repay in the future--your barrier to riches isn't the apocalypse, it's your own trustworthiness.  That's where attorneys and insurance companies come in.  Lloyd's is happy to offer hole-in-one insurance, so the industry has no problem writing policies that pay out upon joyous events.  

With some work, a person should be able to write uninsurance policies up to the value of their net worth (higher in some counties than others).  For those confident of disaster, this is money right there on the sidewalk--and they should pick it up before disaster strikes.  

Let's hope that every one of these uninsurance policies pays off. 

Coda: Yes, this is like writing a call option: You get money up front, only pay out if things go well. But it's even more like insurance...

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CATEGORIES: Finance



COMMENTS (13 to date)
Paul Crowley writes:

How does this compare to Eliezer Yudkowsky's proposal in The Apocalypse Bet?

Jardinero1 writes:

The scenario you describe is analogous to selling covered calls. When you sell a covered call, you are making a bet that the price of your shares will fall.

Furthermore, anytime you sell a negotiable instrument you are making a bet that things have peaked for that instrument. When you sell a share of stock, that, typically, represents a decision that the price will rise no higher.

Yet, the person who buys that share has made a decision that the price will rise further.

Mike Rulle writes:

Most interesting point is your collateral comment. Futures exchanges work this way; i.e., permitting any single entity to risk all their cash and nothing more, thus insulating their individual armageddon from transmitting to others.

Why didn't Dodd Frank start here (and end not far from "here") when making their new rules? AIG was able to not post their cash in their bets because other entities who also did not post cash down the line were desperate to pay anyone to get out of their positions. But by the time they started this it was already too late, leverage had already exceeded their cash collateral.

Of course, what you are saying has been know for some time, maybe forever--and mostly followed---except when not. Hence 2008 comes along from time to time.

Johnson85 writes:

I don't think I understand this. If you can only get an insurance policy of up to your net worth, it doesn't seem like you get much out of the transaction. You could do the same thing by just liquidating your net worth and spending it, aiming to have zero net worth at the end of the world. I guess maybe it helps you get around some limits to liquidating your net worth (e.g., maybe you can't cash out the last 20% of equity in your home), but all in all, it seems like you don't need any insurance, you just need debt with a sufficiently long term.

gwern writes:

Paul: Yeah, this is pretty much the same idea. I'm not sure how original either person is being here: I'd bet that it's the obvious answer to 'how can I monetize apocalypse and consume lots right now?', and possibly even just economics folklore.

Johnson: I agree, long-term debt is also a workable approach and probably even better than Lloyd's, since debt markets are so big and liquid.

Net is not necessarily an issue - suppose you take out a mortgage on your house, with the house as the collateral. Well, you need somewhere to live before the apocalypse, and now you have both the house *and* the amount of the mortgage.

When John Paulson did this (through Goldman Sachs), he won...and Goldman got dragged through the mud of a congressional inquisition for enabling it. Even though Goldman lost money on the Abacus bet.

MingoV writes:
... a person should be able to write uninsurance policies up to the value of their net worth...
I know this is not a grammar blog, but it is written by university faculty who should not add to the abhorrent trend of misusing plural pronouns. If you don't want to use "his" or "her" or the awkward "his or her," then just change to the plural: "persons should be able to write uninsurance policies up to the values of their net worths."
David N writes:

If you find an insurance company that will pay out before an event occurs or does not occur, let me know. It's hard enough to get them to pay after the fact.

Garett Jones writes:

@MingoV:

I should have caught that mismatch of singular and plural. Genuine thanks for noting that.

Tom West writes:

"their" seems fine to me.

It's now commonly used as the gender-neutral possessive (i.e. a short form for "his or her") and I would say it's long become standard usage, even if it was technically incorrect years ago.

JLA writes:

How can I buy insurance against the world ending? If it happens, nobody will be around to pay me back. Not all bad futures are insurable.

Maximum Liberty writes:

Wouldn't the most effective way to do this be to take out a very large balloon mortgage on remote rural property from a distant bank? If the world collapses, you have the land with no one making payment demands. If the world does not collapse, the bank has collateral in the land and a large claim on your net worth. Until then, you just pay interest.

I guess that makes it odd that survivalists are not highly leveraged. Does this mean that they are hedging their bets?

Max

Luke writes:

'The Singularity' links to the wrong URL.

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