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Robert Shiller introduced an approach for reducing exposure to macro risks using real-estate derivatives. He created a successful housing price index with help from Karl Case, the S&P Case-Shiller index. The CME lists futures and options on the index.

Given the convincing case laid out in Professor Shiller's book, one might expect investors to be interested in these housing derivative securities.

Are these real-estate securities useful for protecting me from macro risks in the economy, according to their original intent? If not, why not?

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up vote 4 down vote accepted

The Case-Schiller macro derivatives market has seen very minimal activity.

For example, in the three regional markets of San Diego (SDG), Boston (BOS) and Los Angeles (LAX) on 28 November 2011, there was zero trading volume, no trades settled, no open interest.

CME trading housing futures activity for 3 regions * Source: CME Futures and options activity[PDF] for all 20 regional indices.

Why haven't these real-estate futures caught on with investors?

  • Some new futures products aren't successful, for exogenous or marketing-related reasons (not the case here, I don't believe).
  • Current economic uncertainty is discouraging proprietary traders from entering a new market, one with no prior history.
  • Pension funds are the other plausible buyers of these products. Real estate derivatives offer a unique opportunity to mitigate risk concentration through more diversified holdings, while maintaining liquidity. Yet pension fund managers are unlikely to get approval to invest in a new security type now. Again, this would be due to high levels of uncertainty about the economy in general, as well as the uncertain effect of new Dodd-Frank related securities regulations.

Keep in mind that the CME introduced these indices, with support from Professor Shiller and partner Standard & Poor's several years ago. The CME seems committed to wait this out, as they have shown no indication of dropping the Case-Shiller indices.

There are alternative real-estate investment securities to the Case-Shiller indices. I don't think the market of investors is so small that Case-Shiller has been, in effect, "crowded out" by them. I think it is more likely a matter of known quantities. Also, I don't know how well these alternatives are doing!

Additional reference: CME spec's for Case-Shiller index futures and options contracts.

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In my experience, Shiller is always way before his time with his predictions and often it comes at too early a point for anyone actually making some money to care about. His view is very long term - and I trust his predictions, because he so accurately predicted so many of the homepocalypse, and the measures that would follow. He even predicted that there would be bailouts in his book "Irrational Exuberance".

His opinons were poo-poo'd as doom and gloom and manipulative until every piece started falling apart in the specific order of events (give or take) that they did.

I personally think people like Dr. Shiller make bold predictions that are hard to swallow. The derivatives market is a bit skittish about rolling into bull territory with any kind of housing index, but Warren Buffet's old adage to "buy when everyone is selling and sell when everyone is buying." (paraphrase). I see this as a good long-term investment because I trust Shiller's judgement, he stuck to his guns when the doubts were lobbed at him incessantly (and Krugman, et. al. to some extent), and he turned out to be more than vindicated.

To me, these kinds of sources are usually pretty sound. The man knows what he's talking about, and I wouldn't mind picking up a piece of that action, especially if the market just doesn't trust any real estate investments. It's pretty easy to realize that right now housing will be undervalued and now that mortgage applications are (supposedly) stricter, I think there's a good argument to be made that this economist should continue to exceed expectations.

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