Trading Recession Probabilities

According to InTrade, there’s a 58% chance that the US will see a recession in 2008. That number is higher than the 43% probability assigned to recession by economists polled by the WSJ. But there’s no real discrepancy there, says Dean Baker:

Economists don’t predict recession. Economists don’t predict recessions. (I’m not in the fraternity.) Say it one thousand times until it sinks in. Economists, when we are lucky, recognize recessions after we are already in them. The fact that so many economists are now willing to say that we are facing recessions should be viewed as a lagging indicator of a recession. It is very reliable — I am fairly certain that there has never been a period in which a sizable share of economists forecast a recession and we have not actually been in a recession.

The real question, if Baker is right, is not why InTrade’s recession contract is trading so high; it’s why InTrade’s recession contract is trading so low. There are basically only two explanations: either InTrade’s traders are placing too much faith in the literal accuracy of economic forecasts, or else Baker is placing too much faith in economists’ inability to predict recessions. If you have little faith in economists, maybe the contract is decidedly cheap at these levels. Here’s a live chart:

This entry was posted in economics, prediction markets. Bookmark the permalink.