1. 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 »

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

3. 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."

4. A map of Zaccaria’s route (1298-1299) 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

5. 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 requirements  Payoff volatility  Risks of liquidity mismatch =  Working capital requirements  Payoff volatility  Risks of liquidity mismatch ArrivalDeparture

6. 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 Zaccaria Example Sea loan Pignus Commenda Insurance ? Societatis

7. Adapt business model to create flexibility : « real options » -alum -Transport to Aigues + Sales in Champagne + Sales to other traders In Aigues-Mortes + Sales in Bruges Expand - Transport Roads Sea Aigues-Mortes Stop Phocea

8. 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

9. 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 ….

10. Structure of the transaction Enrico Suppa Baliano Grillo Venture Paleologo Zaccaria Gabriele Spinola Societatis ·1000 £ ·2000 £ ·1 or 2 galleys ·Venture’s management ·Operational expenses and taxes ·Alum ·Galleys Procurati o Contract 1 Notary G. de Camulio (26 Juin 1296) Contract 2 Notary J. Abendo (21 Octobre 1298) Contract 3 : Notary A. de Laneris (29 Octobre 1298) Benedetto Zaccaria

11. + risk coverage by Suppa & Grillo Decision to buyback Decision to start The basic story

12. Function (I) : circumvent usury prohibition (Put/call parity) Long Asset + Borrowing + Long Put OptionCash + 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

13. 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) +

14. Function (I) : Put/call parity at work in Zaccarias deal Call (buy right to buyback later) 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 Put (buy right to put later on debt) 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 Aigues-Mortes Genoa Bruges Genoa =

15. Function (II) : Risk management of real options with financial options Risks Stocks +Transport capabilities = value of management flexibility, information, …but costs + risks Value of finance/insurance Market Currency Casualty Low operating leverage Cash-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)

16. 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

17. The metaphore : Rubik’s cube Insurance Debt Equities Option Contract Sales Management Leasing

18. The unpredictable loop between institutions and markets The institutional context The business model Contracting constraintsContracting innovations Sometimes standardized by markets sometimes not Sometimes driven towards efficiency, sometimes not (polity, monopolies, …) Sometimes failure, sometimes innovations sometimes rationality sometimes luck Sometimes significant, sometimes easy to go around (e.g. kinship solutions)