Aggregate income risks and hedging mechanisms

Abstract

Estimates are made, from time series data on real gross domestic products, of the standard deviation of returns in markets for perpetual claims on countries' incomes. The results indicate that there is much fundamental uncertainty to be hedged. Evidence is shown that there may be only minimal ability to cross hedge these returns in existing capital markets. Methods of establishing markets for perpetual claims on aggregate incomes are examined. Such markets, by allowing hedging of these aggregate income risks, might make for dramatically more effective international macroeconomic risk sharing than is possible today. Retail institutions are described that might develop such markets and help the public with their risk management. However, the establishment of such markets would also incur the risk of major financial bubbles and panics.

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