Hurricane Damage Futures

August 26th, 2006

Posted by: Roger Pielke, Jr.

A futures market called Hedge Street is offering futures contracts on insured hurricane damages for the 2006 season. There are 4 different contracts offered paying out 30 November 2006. The contracts pay out $100 for damage thresholds of $100 million, $1 billion, $10 billion, or $25 billion. As of Friday the contracts last traded at the following values:

>$100M $80.30
>$1B $65.00
>$10B $24.20
>$25B $16.80

According to our research (underway, not peer-reviewed) we are currently about 25% of the way through “damage season” meaning that 75% of the historical damage has occurred after this date. We focus on total economic damages, but if we assume that insured damages are 50% of total economic then according to one of our adjustment methods (we now have 3) the past 106 years would have seen the Hedge Street thresholds exceeded with the following occurrence:

>$100M 70.8%
>$1B 48.1%
>$10B 14.2%
>$25B 5.7%

If we scale each of these figures to 75% of their value to reflect that we are a quarter of the way through damage season then they would be less. What might this mean for investing in hurricane futures?

As of Friday the bid price for each of these thresholds was as follows:

>$100M $75.00
>$1B $62.00
>$10B $15.00
>$25B $10.00

The bid price is that Hedge Street members are willing to buy a contract. If I were investing at Hedge Street (I am not, but thinking about it!) I’d probably be selling at those prices. In particular, selling the $1B contract looks particularly attractive at $62. Based on our current estimates of historical losses, that gives you about a 50% chance of making more than 160% return on your investment. Of course the downside is that you have about a 50% chance of losing your investment. I don’t see an easy way to stop loss, but maybe I am missing something. Anyone?

2 Responses to “Hurricane Damage Futures”

  1. Paul Says:

    I don’t think you are missing anything. This is analagous to the “AGW” bet challenges that are flying around.

    Looking for a hedge? Buy futures in construction and building materials firms with exposure to the hurricane belt.

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  3. Roger Pielke, Jr. Says:

    8/29/06 Bid price = $56

    10% return in 1 day. ;-)