Derivatives-related mishap prompts Duke to abandon validation system

Although every article about the basketball game line policy makes for scintillating reading, The Chronicle could have improved Thursday's article "Validation system suspended" by changing the headline to "Derivatives-related mishap prompts Duke to abandon validation system." Not only is this headline sexier, it gives a better indication of what the problem with the validation system is.

The validation system replaced a spot market (the walk-up line) with an option market. The walk-up line is a spot market because the sellers bring their goods and services-seats at the basketball game-for immediate sale to the consumers, who are the students.

The validation system is an option market. When a student validates, she receives the right but not the obligation to attend a future basketball game. To be exact, the option here is a call option because the student is essentially obtaining the right to buy a seat at the upcoming basketball game.

Options are useful and valuable because they provide insurance. In this case, the validation system provided boredom insurance for Duke students. If a student validates before a game, then she knows that she can go to the upcoming game, which is far better than being bored or having to study during that time. But between validation time and game time, she may receive an opportunity to do something else that she likes even better than going to the game. In this case, she simply doesn't exercise the option and it expires, worthless, at no cost to her other than the time spent going through the validation process.

The University was selling call options to students, presumably without realizing it, or assuming that the option would always be exercised if it was purchased-not a good assumption, given the clever (I hesitate to say rational) nature of Duke students. The University's intention, to offer any unclaimed seats to non-students in order to fill Cameron Indoor Stadium with fans, was certainly a good one-but using options (at least by themselves) isn't the right way to achieve this goal, because as we learned, students will gladly buy options to insure themselves against boredom, especially when they're cheap.

Connel Fullenkamp

Associate professor, Department of Economics