What are the prediction markets saying about the economy?

I have had some interest during the past few years in studying the accuracy of so-called “prediction markets” such as Intrade.com. Markets such as Intrade.com offer bets on the outcomes of any number of future events, including politics, the economy, climate change, current events, entertainment, scientific discoveries, etc. The typical setup is that a contract pertaining to some type of uncertain future event is created which pays $10 if a certain outcome occurs (e.g., whether Obama wins the presidential election, or whether the U.S. economy falls into a depression within a given period of time), and $0 if this outcome does not occur. These markets first gained some notoriety back in the spring of 2003 in the build-up to the U. S. invasion of Iraq when so-called “Saddam Futures contracts” (which placed real money bets concerning whether Saddam Hussein would remain in power) became actively traded. For an assessment concerning prediction market accuracy pertaining to the 2008 election, see my “day after” (November 5) blog entry entitled “Preliminary assessment of the accuracy of the Intrade State-by-State contracts”.

Prices are quoted on Intrade.com in the form of Intrade “points” where 1 Intrade point = $0.10. This way, the market prices resemble probabilities (technically, my inner economist tells me that these are actually “Arrow-Debreu” prices), but for practical purposes, it is quite reasonable to interpret these prices as probabilities.

Anyway, now that I have explained prediction markets in a nutshell, I would like to call attention to the latest (email) summary, provided by Intrade.com’s CEO, Mr. John Delaney, concerning what prediction markets are indicating may lie ahead for the economy (what follows is a direct quote from an email that I received earlier today from Mr. Delaney):

______________________________________

“Gross Domestic Product:

GDP fell by 6.3% in the final quarter of 2008, the single worst drop in quarter of a century. The advance estimate of GDP for the first quarter of 2009 is due for release on April 29th, and the Intrade market on what that figure will be points to an easing in the contraction. There is an 83.0% chance GDP will contract by 4.0% or more but only a 25.0% chance the contraction will be 5.5% or more.

Our markets also indicate that talk of a depression appears unfounded. Although definitions vary, our market (see market specific definition) for a 10.0% decline in GDP from its peak value (currently Q3 of 2008) indicates only a 12.0% chance of this happening before the end of 2009. We have other markets listed here which give a similarly low probability of a depression.

Is there any light at the end of the tunnel? Our markets indicate that things could turn around by the end of 2009. They show a 50.0% probability that GDP growth will be positive in Q4 of 2009, and a 73.0% probability of positive growth in Q1 of 2010.

Unemployment:

The month of March saw the unemployment rate in the United States rise from 8.1% to 8.5%. How bad will it get? The president of the Federal Reserve Bank of Dallas and many others believe that unemployment could surpass 10.0% by the end of the year.

Do the Intrade markets agree? A glance at the figures indicates that an unemployment rate of 10.0% is a very real possibility. The market currently shows a 61.0% probability of the December 2009 unemployment rate topping 10.0%. If you think it will top 10.0% and it does, you would make a $39 profit for every $61 you invested in your opinion. It also shows a 45.0% chance the rate will be 10.5% or more and a 35.0% chance it will be 11.0% or more.

Automakers and Banks:

President Obama recently identified GM and Chrysler as candidates for bankruptcy unless they could quickly and successfully restructure.

Chrysler has been given until the end of April to sort out a partnership with Italian automaker Fiat. The market is uncertain if this can be managed, giving a 50.1% chance of a partnership agreement being successfully concluded by April 30th. The market is also still bullish on Chrysler having to file for bankruptcy by the end of 2009, giving a 79.9% probability of this happening.

The market clearly doubts the ability of GM to successfully manage a turnaround, giving GM a 74.3% chance of having to file for bankruptcy before the end of the year.

In contrast to the struggles of GM and Chrysler, the other member of the big-three, Ford, has fared better. Ford recently shed $9.9 billion in debt, which encouraged a 13.0% jump in their share price. It also reduced their probability of bankruptcy to 16.0%.

The President also forced GM CEO Rick Wagoner to stand down as part of the administration’s plans to restructure the company. This raises the question, will the President also force out those in charge of other companies that have received federal funds? Such as those heading up the large banks who received TARP funds? A market is available on whether the CEO’s of JP Morgan, Bank of America, AIG, Citigroup and Wells and Fargo will be forced out in a manner similar to Wagoner.”

Print Friendly, PDF & Email

Leave a Reply