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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The derivative on which the professors base their unpublished research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.

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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

The New York Times

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