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Predictive Ability of Small Markets: Iowa Electronic Markets

It’s not lost on me that there’s not much volume traded in the Case-Shiller contract. Some use that low volume to automatically dismiss prices suggested by forward quotes. Without getting into the merits of exactly what futures prices for 2013-2015 mean, let me introduce you to my favorite, thinly traded (at least in dollar amount) set of contracts—those on the Iowa Electronic Markets

The IEM has been a great academic laboratory in integrating people’s expectations about the outcome of future events (e.g. the 2012 Presidential race) by relying on a futures format. Individuals can bet on not only whether they expect say Romney to be the Republican nominee for President (see graph), but by allowing a market for that 0-1 (binary) outcome, to come up with the odds of such an event.

Trading accounts are kept small (to avoid gambling issues). The markets are two-sided and there may be many more bids and offers than actual trades. Analysts, academics, and pollsters have relied on these real-time markets to note changes in expectations (see the Perry’s surge and fall).

I see the Case-Shiller contracts as having “the potential” for the same set of predictions on future values of the Case-Shiller indices. Similarly to IEM, the contracts’ predictive power will be more enhanced the 1) more widely known they are, and 2) the more traders choose to narrow bid/asked spreads.

Much like Perry supporters, you don’t have to like what the market is telling you about home prices, but if you disagree, there’s a place where you can put your money where your mouth is (with attractive odds).

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