Bandwidth Benchmark Index Reveals PricingShortcomings

Posted: 08/1999

Bandwidth Benchmark Index Reveals Pricing Shortcomings

In the first application of RateXchange's new TeleCommodities market indices, traders could assume significant temporal arbitrage opportunities. The Real-Time Bandwidth Exchange*Revealed Price Index (RTBX*RPI), which tracks the current weighted average price, is applied to DS-3 bandwidth for major U.S. East-West Coast routes in the chart below for RateXchange trades since January 1998. For this time period, the average rate for a DS-3 declined 63 percent to $31,878 per month. Also during this time period, the average rate for an East-West Coast T1 fell 51 percent to $2,280 per month.

The RTBX*Revealed Forward Price Index (RTBX*RFP), which reveals prices the market sets for future dates according to contract term commitments, also is applied to two critical periods. The RFP-360 in October 1998, when the RPI was $54,241, reveals the price the market is betting on a year later to be $38,133. This seems like a reasonable discount from its present value, but the benefit of hindsight reveals that prices will be significantly lower if the present trend continues. Sellers may have gained an advantage by locking in future prices through term commitments well before the beginning of the current decline in April.

Image: DS-3 Bandwidth RTBX*RPI and RTBX*RFP-360 Indices

The RTBX*RFP-360 for May 1999 reveals that the most recently traded contracts, through their term commitments, set a price for May 2000 of $30,121. Apparently the market is betting that prices will hold relatively constant over the next year. Given the general trend of DS-3 rates, it seems more than reasonable that sellers sell as much as possible at this current price.

The "No Temporal Arbitrage" principle for a liquid bandwidth market, described in the "Price Bandwidth Derivatives" paper on the RateXchange website, simply states that if the market bets future prices incorrectly it creates arbitrage opportunities. Today the market is betting that rates will not decline significantly in the next year, which is contrary to what we commonly understand about bandwidth pricing trends. If a reseller believes prices will fall below $30,121, it could take advantage of an arbitrage condition. It could lock in a 24-month contract to sell, buy two 12-month contracts (one now, one a year later) and even take a loss on its cost of providing the route in the first year to gain a significant profit in the second year. Simply put, a reseller could sell in the first year and buy in the second.

The market's understanding of how to set future prices is a precondition to the creation of a futures or derivatives market. The first step is recognizing how carriers set future prices today with contract term commitments.