The Zaccaria Deal :Contracts and options to fund a Genoese shipment of alum to Bruges in 1298 Eric Briys, Didier Joos de ter Beerst IEHC Congres, Helsinki, 23 August 2006 Session 110 « Tools for trade »
A methodological starting point : Alfred Marshal "I had a growing feeling in the later years of my work at the subject that a good mathematical theorem dealing with economic hypotheses was very unlikely to be good economics, and I went more and more on the rules : (1) Use mathematics as a shorthand language, rather than an engine of inquiry; (2) Keep to them until you have done ; (3) Translate into English; (4) Then illustrate by examples that are important in real life; (5) If you can't succeed in (4) and (3), burn the mathematics This last I did often."
Call Stock in key location 3000 people working for Zaccaria in Phocea Large fleet of a dozen of galleys, nave, cocha A map of Zaccaria’s route (1298-1299) 650 cantari of alum (= 35 tons)
Problem 1 : long distance cash-and-carry (no order, forward/futures) • Time • Distance • Lack of Information Departure Arrival • Cash out • Goods • Transport • Tax Cash in + Revenues • Risky payoff • Price • Casualty • Currency Upfront fixed capital • = • Working capital requirements • Payoff volatility • Risks of liquidity mismatch
Classical medieval risk management tools Example Zaccaria • Trader of many different types of commodities • Alum was shipped to France, Flanders, England, • Convoy with Zaccaria and other alum traders before « Officium Gazarie » • Large fleet to spread assets • Mitigation 1 : Assets diversification • Mitigation 2 : Geographical diversification • Mitigation 3 : Pooling shipments between traders • Mitigation 4 : diversify assets into different galleys • Transfer risk • Finance risk Insurance ? Sea loan Pignus Commenda Societatis
Adapt business model to create flexibility : « real options » Stop + Sales to other traders In Aigues-Mortes Phocea Aigues-Mortes + Sales in Bruges Sea • alum • Transport to Aigues - Transport Expand Roads + Sales in Champagne
Critical assets Information Storage Transport capability Functions Learn about market conditions in distance places Wait-and-decide at the right time: before decision to stop or expand Organise « expand » decision (management, pool shipments, fund venture) Ability to move quickly from one market to another Business assets required to unlock option value • Zaccaria • Admiral of Philip the Fair (Flanders, England) • Supply « monopoly » : information on traders, shipments, price,… • Storage capabilities in key strategic location (Aigues-Mortes) • A large fleet of nave, galleys, cocha
Contracting constraints and supports • Agency issues but reputation and kinship (albergo) • Incomplete markets (no stock exchange, no derivatives, no « insurance ») but many existing standard contracts • Usury prohibition: Naviganti vel eunti ad nundinas of 1234 : Pope Gregory IX • Cost/time of contract to deal with business and contracting risks vs benefits • Trade-off between contract complexity and simplicity(incompleteness) : usually from complex to simple but ….
Structure of the transaction Contract 1 Notary G. de Camulio (26 Juin 1296) Procuratio Benedetto Zaccaria Gabriele Spinola Contract 2 Notary J. Abendo (21 Octobre 1298) Societatis ·1000 £ Enrico Suppa ·1 or 2 galleys Paleologo Zaccaria Venture ·Venture’s management ·Operational expenses and taxes ·Alum ·Galleys Baliano Grillo ·2000 £ Contract 3 : Notary A. de Laneris (29 Octobre 1298)
Decision to buyback Decision to start + risk coverage by Suppa & Grillo + risk coverage by Suppa & Grillo The basic story
Function (I) : circumvent usury prohibition (Put/call parity) Accepted by the Church Prohibited by the Church The Zaccarias Protective Put Fiduciary Call = Long Asset + Borrowing + Long Put Option Cash + Short Asset (Sales) + Long Call Option = Short Put Option + Short Asset + Lending - Cash + Long Asset (Sales) + Short Call Option Suppa & Grillo
Function (I) : The logic of Put/call parity (H. Stoll, 1969) CASH (From DEBT or SALES) Portfolio 1:BUY CALL ON ASSET Read also Knoll (2002, 2004) Payoff Portfolio 1 = Payoff Portfolio 2 = + ASSET Portfolio 2 :BUY PUT ON DEBT
Function (I) : Put/call parity at work in Zaccarias deal = Borrow + Put on Put on Put on Put Sales + Put on Call on Put on Call Borrow Genoa Sales + asset + cash of debt issue (3000 £) - asset + cash from sales (3000 £) Aigues-Mortes Put (buy right to put later on debt) Call (buy right to buyback later) - transport - transport Put Put - « sea loan » indemnity to Bruges (max 3,000 £) - loss at sea to Bruges (max 3,000 £) Bruges Put Call - principal with interest 3,780 £ - buyback price of 3,780 £ Put Put - Pignus indemnity to Bruges (max 3,000 £) - Pignus indemnity to Bruges (max 3,000 £) Genoa
Function (II) : Risk management of real options with financial options Merchant = alum + Foundouks (warehouse) + Gallei/Cocha/Nave (ships) Stocks +Transport capabilities = value of management flexibility, information, …but costs + risks External risks Market Currency Casualty 1. Interaction between financial and real options 2. The higher the risks, the higher the value of options Risks Business model/contracts Low operating leverage Cash-and-carry Value of finance/insurance Banchiarus (« Financiers ») = cash £ + risk transfer
Conclusion (functions from Merton 1995, Merton & Bodie, 2005): Empirically we have crunched numbers : Buyback option = always out-of-the-money in Bruges • Pooling funds : 3,000 £ were gathered jointly from Suppa and Grillo • Transfer funds: Zaccaria received cash for a venture to-from Bruges • Complete incomplete markets: The contract fills gaps (insurance, …) • Manage Risk.Risk (sea, market, …) transfer and financing • Control agency risks. agency and informational issues. • Screening/monitoring: quality of alum, accounting books and scriba on board. • Incentives : e.g. option to start + Investment (“no “cheap talk”) • Asset-backed loan (cfr Contract theory literature, also Gonzales de Lara, 2002) • Increase asymmetry of information with Competitors. • Fostering family and business networks. • Create Legal arbitrage (State, Church).
The metaphore : Rubik’s cube Debt Leasing Sales Option Contract Insurance Equities Management
The unpredictable loop between institutions and markets Sometimes standardized by markets sometimes not Sometimes driven towards efficiency, sometimes not (polity, monopolies, …) The institutional context Contracting constraints Contracting innovations Sometimes failure, sometimes innovations sometimes rationality sometimes luck The business model Sometimes significant, sometimes easy to go around (e.g. kinship solutions)