Saturday, March 6, 2010

Hedging World Cup Risk

Today I was walking around Barcelona and saw this interesting time-deposit offer from Banesto (a local bank). They promise you 3%/year, but IF Spain wins the World Cup, the investor gets 4%.

Around the World Cup we see all kinds of offers like this (in Spain, the UK, and Brazil at least): buy a flat-screen TV and if Brazil wins you get another one, etc.

An interesting question is how much money does the bank expects to spend with this offer? How should  this be hedged?  Of course, based on historical probabilities they won't lose a dime, but with Spain being one the favourites, what to do to at least find an estimate? 

Supose that the bank's reinvestment rate is 4%. If Spain does not win the World Cup, they make a 1% profit. If Spain does win, they make zero. The expected return is the 1%*(Prob Win), which looks good on their side given previous history.

I wonder if they could hedge this against a portfolio of online bets held by betting houses. 

Any ideas? This might turn into a nice exam question or topic for the derivatives course.

1 comment:

  1. I remember the time I worked in the finance market, people were studying correlation between winning the WC and stock exchange performance for the following year. Historical data of Merval 86 was one of the series desired. If Banesto is also betting in similar studies, I believe the 1% prob win is the only chance they have. At least until they have Zapatero in charge.