Predictive ability of small markets. Iowa Electronic Market

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).