Economic Derivative

AAA

DEFINITION of 'Economic Derivative'

A relatively new form of derivative contract (the first ones were traded in 2002) that is based on the future value of some national economic indicator, such as non-farm payrolls, the purchasing manager's index, retail sales levels and the gross domestic product. Most of these economic derivatives are in the form of binary or "digital" options, whereby the only payout options are full payout (in the money) or nothing at all (out of the money). Other types of contracts currently traded include capped vanilla options and forwards.

Economic derivatives have become attractive for their ability to mitigate some of the market and basis risks found in standard investment vehicles.

INVESTOPEDIA EXPLAINS 'Economic Derivative'

For example, a binary option trading on the GDP would pay its face value if, when the official GDP release is made (the exercise date), the GDP value falls within a specific range (strike range). If the GDP figure is outside of this range, the option expires worthless.

By looking at the implied probabilities of different outcomes, economists and investors can compare economic derivatives to Wall Street estimates and look for discrepancies between the two estimations. As might be expected, the market-driven process seen in derivatives pricing has shown itself to be the more consistently accurate predictor of future indicator release values.

RELATED TERMS
  1. Financial Analysis

    The process of evaluating businesses, projects, budgets and other ...
  2. Risk Analysis

    The study of the underlying uncertainty of a given course of ...
  3. Indicator

    Statistics used to measure current conditions as well as to forecast ...
  4. Vanilla Option

    A financial instrument that gives the holder the right, but not ...
  5. Derivative

    A security whose price is dependent upon or derived from one ...
  6. Gross Domestic Product - GDP

    The monetary value of all the finished goods and services produced ...
Related Articles
  1. Options & Futures

    Are Derivatives A Disaster Waiting To Happen?

    They've contributed to some major market scandals, but these instruments aren't all bad.
  2. Options & Futures

    Explaining The World Through Macroeconomic Analysis

    From unemployment and inflation to government policy, learn what macroeconomics measures and how it affects everyone.
  3. Options & Futures

    The 4 Advantages of Options

    Flexible and cost efficient, options are more popular than ever. Find out why.
  4. Retirement

    Economic Indicators To Know

    The economy has a large impact on the market. Learn how to interpret the most important reports.
  5. Options & Futures

    A Detailed Look Into China's Options Market

    As the Chinese options market gradually takes shape, we provide an overview, including details of the initial phase and building blocks, primary beneficiaries, the impact on the overall financial ...
  6. Options & Futures

    How do you trade put options on E*TRADE?

    Learn all about put option trading at E*TRADE. Explore margin accounts and become familiar with the different types of option writing.
  7. Trading Systems & Software

    How do you trade put options on Ameritrade?

    Learn about option trading with TD Ameritrade. Explore the different types of options and their possible impacts on the investors that write them.
  8. Options & Futures

    What is the difference between a short position and a short sale?

    Learn how short selling and short positioning are different, specifically in regards to the nature of the commodity being bought and sold.
  9. Options & Futures

    Are there any risks involved in trading put options through a traditional broker?

    Explore put option trading and different put option strategies. Learn the difference between traditional, online and direct option brokers.
  10. Fundamental Analysis

    What's the difference between r-squared and adjusted r-squared?

    Learn how R-squared and adjusted R-squared values differ, how they are calculated, the relationship between them and how to use them to make accurate estimates.

You May Also Like

Hot Definitions
  1. Prospectus

    A formal legal document, which is required by and filed with the Securities and Exchange Commission, that provides details ...
  2. Treasury Bond - T-Bond

    A marketable, fixed-interest U.S. government debt security with a maturity of more than 10 years. Treasury bonds make interest ...
  3. Weight Of Ice, Snow Or Sleet Insurance

    Financial protection against damage caused to property by winter weather specifically, damage caused if a roof caves in because ...
  4. Weather Insurance

    A type of protection against a financial loss that may be incurred because of rain, snow, storms, wind, fog, undesirable ...
  5. Portfolio Turnover

    A measure of how frequently assets within a fund are bought and sold by the managers. Portfolio turnover is calculated by ...
  6. Commercial Paper

    An unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories ...
Trading Center