The Zaccaria Deal (I) : On modern finance and history
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Transcript of The Zaccaria Deal (I) : On modern finance and history
The Zaccaria Deal (I) :
On modern finance and history
Eric Briys, Didier Joos de ter Beerst
Congrès AFFI Poitiers, 26 juin 2006
The last twenty years of Modern Finance : « again » !
• Miller (1986) enthusiastic paper “Financial Innovation: The Last Twenty Years and the Next” twenty years have gone by. It makes sense to see whether or not the optimistic views of Miller have been confirmed by the facts.
• Four key areas, all revived by Option Pricing Theory (OPT):
– OPT and new breed of derivative securities– Modelling of credit/default risk through OPT insights– Risk management: Var, ART– Real options and interaction with financing
• Merton frames these developments in what he calls “Functional Finance” : History “ As If” = No History
Modern Finance: Pitfalls of the silo approach
• Option pricing: Hakansson’s catch 22 paradox
• René Stulz:
“Telling students simultaneously that they should compute net present values using the
Modigliani-Miller capital budgeting paradigm, that they should optimize the firm’s capital
structure by trading off costs of distress against equity cost, and finally that they should
worry about risk management amounts to pure schizophrenia and does not have the
slightest intellectual foundation in modern finance theory.[…] It is a peculiarity of finance
that we spend so much time on teaching about a world without frictions when
everything that makes finance interesting has to do with what happens in the
presence of frictions.”
• Unfortunate outcome: “Happy people do not have a history”.
• Well, they do have one!
Key messages
• The framework we propose consists in core messages:
– Financial and real options were explicitly contracted in Late Middle-Age, and before.
– Contracts are “bricolage” of options to complete incomplete markets
– Options were “bricolage” in Late Middle-Age, they still are today!
– There is no universal theory but : “Proof is in pudding”
A map of Zaccaria’s route (1298-1299)
Bruges
Phocea
GenovaAigues-Mortes
Cadix (Puerto San Maria)
Majorca
Sardegna
Sicily
Places mentioned in the contract
Potential calls
650 cantari of alum(= 35 tons)
3000 people working for Zaccaria in Phocea
Large fleet of a dozen of galleys, nave, cocha
Stock in key location
Call
Contracting constraints and supports
• Limited cognitive load about the future
• Lack of markets : no stock exchange, no futures, no « insurance », no limited liability
• Agency risks in long-distance maritime trade
• Trade-off between contract complexity and simplicity(incompleteness)
• Property rights in Bruges
• Usury prohibition (see under)
• Cost/time of contract to deal with business and contracting risks vs benefits
• Institutions :
• Law • Notary, Scriba (accounting),
judges, arbitrers• Standard contracting from
developped mainly in Genoa :–Commenda (equity-type)–Loca (equity-type)–Societatis (JV)–Nolis (lease)–Instrumentum ex causa cambi–...
• Private-order contracting (alberghi)
• Entrepreneurship, Innovation, knowledge
Constrain contracting efficiency Support contracting efficiency
First simplified model : single venture :buyback with embedded « sea loan »
120,0-(casualty)|,0)10t1Q
100-Max(100Put *t1QP casualty) (no|*
t110PCallMax t010P - 100 zV
Short asset + long cash + Long Call with Long Put « sea loan » = (compounded options)
Convention :
Vz = value of the venture, z = the indicator for Zaccaria,
T0 T1, departure, arrival
Vz = value of the venture,
P = price (with P, P *, the commodity market price in Aigues-Mortes, in Bruges),
Q = quantity,
1
A simplified tree : a put on a call on a put on a call
Call
Put
Put
Call
(red nodes = decision, white = events)
Scenario 1Scenario 1
Scenario 2Scenario 2
Scenario 3Scenario 3
Scenario 4Scenario 4
Scenario 5Scenario 5
Scenario 6Scenario 6
Timing
Arrival in Genoa, if no casualty. Payment of 3,780 G £ to
Suppa & Grillo
Contract agreement in
Genoa. Zaccaria receives 3,000 G
£.
1st November 1298 (t= 0)
1st May 1299 (t = 1)
1st November 1299(t = 3)
6 month waiting deadline
1st August 1299 (t = 2)
Arrival in Bruges, if no
casualty, and decision to
buyback alum
3 month trip Aigues-Mortes - Bruges
3 month trip Bruges - Genoa
Starting date of the venture, or repayment of
3,250 £ if Zaccaria does not
leave Genoa
Full model (2) : Zaccaria ’s payoff
p(1)1t
250-)0t
Pa-1t
650(PazV
p(1)-1t1
G)(N p(2)1 p(3) 2
αNp(4)-1 3t
Gp(3) -12t
3,780p(4)-1 3t
G2t
)d*Q*(Pp(4)
3t),0
650dQ
3,500-S(3,500 MaxPut Max CallMax Call
P = price (with P, P *, P **, respectively, price in Aigues-Mortes, in Bruges and Genoa),
Q = quantity, a = alum, d= drapery
N = transport cost for back-and-forth , G = galley (s), aN = market price of transport (nolis)
S = exchange rates
p(1) = Decision to buyback in Aigues-Mortes [1-p(1)] = Decision to Start the venture
p(2) = Casualty before Bruges (full loss) [1-p(2)] = Safe arrival in Bruges
p(3) = Decision to lease galleys (no buyback in Bruges) [1-p(3)]= Decision to buyback
p(4) = Casualty before Genoa (way back) [1-p(4)] = Safe arrival in Genoa
2
Zaccaria ’s payoff (scenario 1, …, 6)
p(1)1t
250-)0t
Pa-1t
650(PazV
p(1)-1t1
G)(N p(2)1 p(3) 2
αNp(4)-1 3t
Gp(3) -12t
3,780p(4)-1 3t
G2t
)d*Q*(Pp(4)
3t),0
650dQ
3,500-S(3,500 MaxPut Max CallMax Call
Payoff no-departure
Decisionto start
Decisionto buyback
Casualty No-Casualtyon the
way back
Decisionnot to buyback
No-Casualtyon the
way back
Upfront Investment
Buybackprice
Sea loan(indemnity)
Payoff from drapery
Rent cashGalleyrecovered
2
Decision 1 : Start the venture [1-p(1)]
01t
250-)t0Pa-1t
650(Pa1t
G)(N casualty) p(no 2t
2αN)causalty' p(no-1
t3G p
1tzE
Payoff no departure
Up frontExpenses in
transport(invest Galley +
pay salaries, food)
Cash in Nolis (transport)
if galley arrives in Bruges
Galley recovered in case of safe
arrival
Start if (Scenario 2 +Scenario 3 +Scenario 4) - (Scenario 1) > 0 Start if (Scenario 2 +Scenario 3 +Scenario 4) - (Scenario 1) > 0
2
Decision 2 : buyback [1-p(3)]
0t22
αNcasualty' p(not3
G3,780)casualty' p(no t3
Gt2)d*Q*(P)'p(casualty t3
),0650
dQ3,500-S(3,500 MaxPut p
t2 Ez
Cash in Nolis (transport)
if galley arrives in Bruges
Buyback price of 3,780 £
Payoff from drapery in Genopa
Defalult up to 3,500 Tournois
in case of casualty
Galley recovered in case of safe
arrival
Buyback if (Scenario 5 +Scenario 6) - (Scenario 3 +Scenario 4) > 0 Buyback if (Scenario 5 +Scenario 6) - (Scenario 3 +Scenario 4) > 0
2
Put/call parity
Long Put Option + Long Asset + Borrowing * Cash + Short Asset (Sales) + Long Call Option
Short Put Option + Short Asset + Lending - Cash + Long Asset (Sales) + Short Call Option
The Zaccarias
Suppa & Grillo
=
=
Protective Put Fiduciary Call
Prohibited by the Church Accetped by the Church
Back to the First model : the venture as a « sea loan »: Loan + default
,0(casualty)|,0)10T1Q
100-Max(100Put T1QP casualty) (no|T110P120Max Put t1120 - 100 zV
Long cash + short debt + Long Put on debt with Long Put « sea loan » (compounded options)
Prohibited by the Church
Conclusion :
• Pooling funds : 3,000 £ were gathered jointly from Suppa and Grillo
• Transfer funds: Zaccaria has received cash for a venture to and from Bruges
• Complete incomplete markets: innovative solution that completes market gaps
• Manage Risk. The contract spreads, through transfer and financing, the various risks among the parties to it.
• Control agency risks. agency and informational issues. • Screening/monitoring: quality of alum accounting books and scriba on board.• Incentives : ex ante selection and ex post control of parties: The option to start (“find and reveal
information”, no “cheap talk”
• Increase asymmetry of information with Competitors.
• Fostering family and business networks.
• Create Legal arbitrage (State, Church).
Empirically we have crunched numbers :
Buyback option
=
always out-of-the-money in Bruges