Friday, October 13, 2006

Dorky Econ Stuff

For all you non-econ majors out there, there's an extensive literature about the use of markets to predict future events. The idea is simple--set up a trading market where prognosticators can buy "futures" of particular events happening. For example, you can now buy a share of the Detroit Tigers to win the World Series for $5 on Tradesports.com. If the Tigers win, you get $10. If they don't, you're out your $5. In other words, the market is predicting the Tigers have exactly a 50/50 chance of winning the World Series. Economists have done study after study, and the results are clear--markets are extremely successful at predicting the outcome of various types of events.

In particular, economists have found that markets are very good at predicting elections.

Today, the price of a share of stock for the GOP retaining control of the House is $3.84, implying that the markets think that the Democrats have a 61.6% chance of capturing the lower chamber.

Not bad odds.

8 Comments:

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At October 17, 2006 5:07 AM, Anonymous Debz said...

Good post. Futures are efficient mechanism for elections and such, but they do have certain limitations. For example, when the Pentagon's DARPA (reasonably?) suggested setting up a futures market that predicts terrorist attacks, assassinations or military coups d'etat (the "Policy Analysis Market"). In addition to the ethical concerns, I'm not sure how good publicly available information on specific terrorist attacks would be to create a well-functioning market. It would be similar to trying to predict major scandals (sudden and without any prior indication).

 
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