MACROECONOMIC DERIVATIVES: MORE VIABLE THAN FIRST THOUGHT!

Vipul K. Bansal, John F. Marshall,and Robert P. Yuyuenyongwatana

This study provides evidence on the effectiveness of macroeconomic swaps to hedge business cycle risk when the macro swaps are pegged to gross domestic product. The study examines the revenue streams of ten firms in different industries and demonstrates that in many cases the ability to reduce revenue/cash flow volatility via macroeconomic derivatives is considerable. The results are significant in all cases at a 0.1% level. Importantly, it is demonstrated that when structuring macroeconomic derivative products, the number of periods of lag is an important consideration--as is the choice of a macroeconomic index. Evidence of the magnitude of business cycle risk is implied by the analysis and this is the key to both measuring and managing this important, but largely ignored, form of risk.