The Econophysics Blog

This blog is dedicated to exploring the application of quantiative tools from mathematics, physics, and other natural sciences to issues in finance, economics, and the social sciences. The focus of this blog will be on tools, methodology, and logic. This blog will also occasionally delve into philosophical issues surrounding quantitative finance and quantitative social science.

Friday, March 31, 2006

Ticket Futures Market and Risk-Neutral Pricing

Alan Krueger, an economics professor at Princeton University, wrote an interesting article a while back on the emerging market for ticket futures -- i.e., like forwards/futures for pork bellies, companies are beginning to offer futures for tickets to sporting and other events in the uncertain future -- for the 'Economic Scene' column in the New York Times. You can read the piece at http://www.krueger.princeton.edu/02_02_2006.htm

Prof. Krueger offered an interesting example of pricing under uncertainty and risk using the example of a futures contract for a Super Bowl ticket. Here is an excerpt:
If fans are risk-averse, then ticket futures add economic value. To see this, suppose that there is a 10 percent chance of a fan's team reaching the Super Bowl and that a futures contract costs $250 while a ticket could be purchased the week of the game for $2,500. At these terms, a risk-loving fan intent on going to the Super Bowl if his team plays would wait to buy a ticket for $2,500, and a risk-averse fan would buy a futures contract for $250.

Indeed, a risk-averse fan would be willing to pay more than $250 for a futures contract in this situation. Like an insurance policy, ticket futures sell at a premium over their expected value because they help risk-averse buyers hedge against uncertainty.

To gauge the size of the premium, note that a fan could guarantee a ticket to the Super Bowl by buying a futures contract for every team in a conference; one is bound to make it. Call this expenditure the sure-thing price of a ticket. If fans were risk-neutral, the sure-thing price would equal the price that tickets are expected to cost at game time — say $2,500 this year. The excess of the sure-thing price over $2,500 gives a rough indication of the market valuation of insuring against risk.

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