Betting on a “Depression”

A friend of mine who bets on Intrade (he made money correctly betting that Rod Blagojevich would survive into this year) alerted me to the fact that Intrade now has a market for whether the U.S. will go into “depression” in 2009 (warning: that link will resize your browser window). Their definition of “depression” is “a cumulative decline in GDP of more than 10.0% over four consecutive quarters,” but they don’t really mean that. What triggers the payout is if the sum of the quarterly annualized GDP growth rates for four consecutive quarters is less (more negative) than -10.0%. (To see the difference: GDP in Q3 2008 was 0.13% smaller than in Q2 2008, but this was reported as an annualized rate of -0.5%.) This would mean that the total economic contraction over those four quarters would be more than (about) 2.5%. This would make the current recession the worst since at least 1981-82 (which had a total peak-to-trough decline of 2.6%), but not necessarily anything that anyone would call a depression.

On to the interesting bit: the last price for this market was 56.3, meaning that the market assigns a 56% probability to the occurrence of a “depression” as defined by Intrade. The average forecast collected by the Wall Street Journal shows a “cumulative decline” of 7.8% (from Q3 2008 to Q2 2009 the forecasts are for contractions at annual rates of 0.5%, 4.3%, 2.5%, and 0.5%), or a peak-to-trough contraction of about 1.9%. Of the 54 individual forecasts collected by the Journal (you can download the data to a spreadsheet), 22, or 41%, are predicting a depression by Intrade’s definition.

So Intrade is more pessimistic than the experts. There has been a lot of talk about the accuracy of prediction markets like Intrade, but a lot depends on the liquidity of the individual market, and this one doesn’t have much (you can see all the outstanding bids and asks). We’ll just have to wait and see who wins this contest.

4 thoughts on “Betting on a “Depression”

  1. I am not surprised that “investors” (actually, gamblers) at Intrade have a more dire assessment of the current economic trend than the “experts” WSJ monitors. So far, the consensus of economists and analysts that WSJ tracks has consistently underestimated the negativity of virtually every economic or market benchmark for more than a year. I suspect that the Intrade odds are closer to the mark, and I don’t believe there is a chance the economy will reverse until economists/analysts begin consistently overestimating the negativity in the economy and the market.

  2. The BEA report on 4th quareter GDP will probably be out by the end of this month. It will probably show a “cumulative decline” of 6.5% or an actual decline of 1.6% (so far). In short we will already be two thirds of the way to Intrade’s definition.

    My own seat of the pants estimates are coming up with a peak to trough decline of just under 4%. Bard College’s economics department is coming up with an estimate of over 4%. Nouriel Roubini has been forecasting a peak to trough decline of 5%. I personally would take the Intrade odds.

    Whether this constitutes a depression is another issue. I like Brad Delong’s definition: one month of 12% unemployment or three years of double digit unemployment. By that definition we’ve only had two depressions in the U.S. One in the 1890’s, and of course the Great Depression.

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