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 »

The original document (Archivio di Stato, Genoa, notai antichi)

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."

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

Problem 1 : long distance cash-and-carry (no order, forward/futures)

Cash in

+ Revenues

Cash out

-Goods-Transport-Tax

• Time• Distance• Lack of Information

Upfront fixed capital

Risky payoff

• Price• Casualty• Currency

=Working capital requirementsPayoff volatilityRisks of liquidity mismatch

=Working capital requirementsPayoff volatilityRisks of liquidity mismatch

ArrivalDeparture

Classical medieval risk management tools

• 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

• 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

ZaccariaZaccariaExampleExample

Sea loanPignus

Commenda

Insurance ?

Societatis

Adapt business model to create flexibility : « real options »

-alum-Transport to Aigues

+ Sales in Champagne

+ Sales to other tradersIn Aigues-Mortes

+ Sales in Bruges

Expand

- Transport

Roads

Sea

Aigues-Mortes

Stop

Phocea

Business assets required to unlock option value

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

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

Enrico Suppa

Baliano Grillo

VentureVenture PaleologoZaccaria

GabrieleSpinola

SocietatisSocietatis·1000 £

·2000 £

·1 or 2 galleys

·Venture’s management

·Operational expenses and taxes

·Alum

·Galleys

Procuratio

Procuratio

Contract 1Notary G. de

Camulio (26 Juin 1296)

Contract 2Notary J. Abendo

(21 Octobre 1298)

Contract 3 : Notary A. de

Laneris (29 Octobre

1298)

BenedettoZaccaria

+ risk coverage by Suppa &

Grillo

+ risk coverage by Suppa &

Grillo

Decision to buyback

Decision to start

The basic story

Function (I) : circumvent usury prohibition (Put/call parity)

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

The Zaccarias

Suppa & Grillo

=

=

Protective Put Fiduciary Call

Prohibited by the Church Accepted by the Church

Function (I) : The logic of Put/call parity (H. Stoll, 1969)

Portfolio 1: BUY CALL ON ASSET

Portfolio 2 : BUY PUT ON DEBT

Payoff Portfolio 1 = Payoff Portfolio 2

=

CASH (From DEBT or SALES)

ASSET

Read also Knoll (2002, 2004)

+

Function (I) : Put/call parity at work in Zaccarias deal

Call (buy right to buyback later)

Put

Put

Call

- asset + cash from sales (3000 £)

- transport

- loss at sea to Bruges (max 3,000 £)

- buyback price of 3,780 £

- Pignus indemnity to Bruges (max 3,000 £)

Sales

Sales + Put on Call on Put on Call Sales + Put on Call on Put on Call

Put (buy right to put later on debt)

Put

Put

Put

+ asset + cash of debt issue (3000 £)

- transport

- « sea loan » indemnity to Bruges (max 3,000 £)

- principal with interest 3,780 £

- Pignus indemnity to Bruges (max 3,000 £)

Borrow

Borrow + Put on Put on Put on Put Borrow + Put on Put on Put on Put

Aigues-Mortes

Genoa

Bruges

Genoa

=

Function (II) : Risk management of real options with financial options

RisksRisks

Stocks +Transport capabilities = value of management flexibility, information, …but costs + risks

Stocks +Transport capabilities = value of management flexibility, information, …but costs + risks

Value of finance/insuranceValue of finance/insurance

MarketCurrencyCasualty

Low operating leverageCash-and-carry

Business model/contracts

External risks

Banchiarus (« Financiers ») = cash £ + risk transfer

1. Interaction between financial and real options

2. The higher the risks, the higher the value of options

Merchant = alum + Foundouks (warehouse) + Gallei/Cocha/Nave (ships)

Conclusion (functions from Merton 1995, Merton & Bodie, 2005):

• 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).

Empirically we have crunched numbers :

Buyback option

=

always out-of-the-money in Bruges

The metaphore : Rubik’s cube

Insurance

Debt

Equities

Option Contract

Sales

Management

Leasing

The unpredictable loop between institutions and markets

The institutional context

The business model

Co

ntr

acti

ng

co

nst

rain

ts

Co

ntr

acti

ng

inn

ova

tio

ns

Sometimes standardized by

markets sometimes not

Sometimes driven towards efficiency,

sometimes not (polity, monopolies, …)

Sometimes failure, sometimes innovations sometimes rationality

sometimes luckSometimes significant,

sometimes easy to go around(e.g. kinship solutions)