Saddam futures indicate 5% fall
February 18 2003
Few people would disagree with the forecast that share prices would drop if
war started tomorrow in Iraq. But two Stanford economics professors Eric
Zitzewitz and Justin Wolfers, go further, predicting that the market would
drop 5 per cent.
Academics rarely make precise short-term market predictions. The professors
arrived at theirs by using standard econometric analysis and an unusual
derivative that trades at www.tradesports.com, based in Dublin. At this Web
site, you can bet on whether Duke will win the NCAA basketball title,
whether Chicago will win the Oscar for best picture or where the Dow Jones
industrials will end 2003. According to John Delaney, the site's chief
executive, most of its active users are traders from Wall Street or Chicago
futures exchanges.
The derivative on which the professors base their unpublished research is a
futures contract on Saddam Hussein's presidency. The contract, which was
trading at $US7.50 on Friday, will pay $US10 if Saddam is not Iraq's
president on June 30; otherwise it will pay nothing.
The professors assume that Saddam won't step down voluntarily and so argue
that the contract reflects traders' assessment of the probability of a war
resulting in his ouster. The price suggests the market assesses this
probability as 75 per cent between now and mid-year.
The professors acknowledge that the contract may seem too bizarre to be the
basis of serious research; and concede that its trading volume is low, just
over $US140,000 ($237,000) in the past five months. Yet they say its price
accurately gauges the probability of an Iraqi war.
They point out that turnover is still higher than that of the Iowa
Electronic Market, a real-money futures exchange administered by the
University of Iowa that allows speculating on the US presidential election.
Despite trading volume that has averaged just $US108,000 an election, these
Iowa contracts have had an excellent track record.
Professors Zitzewitz and Wolfers say markets in general reflect more wisdom
than any single person can possibly have, and thus do a better job of
assessing probabilities. That holds true not only for large markets, they
say, but also for small and unconventional ones - assuming no one single
big bet has skewed the odds.
The professors correlated the S&P500 with the Saddam contract to determine
their expected percentage fall. For details, see
http://faculty-gsb.stanford.edu/zitzewitz/Research/iraq.pdf
