InvestMacro

By Amitrajeet A. Batabyal, Rochester Institute of Technology 

The world as we know it cannot function without oil, giving oil-producing countries an advantage economists call market power. Nations that produce oil are able to set the price, while countries that rely on oil have little choice but to buy it at prices determined by the seller.

While this asymmetry in market power generally favors the seller, in response to the war in Ukraine, a group of global oil buyers are trying to leverage their economic purchasing power to weaken Russia’s strength as a major global oil producer. The European Union and the United States have both imposed bans on the purchase of Russian oil. In solidarity, other nations like Australia and Canada have also decided to not purchase Russian oil anymore.

Now, the G-7 countries – a group of democracies including the United States that try to coordinate global policy – are developing a price cap they hope nations will agree to when paying for Russian oil to further limit Russia’s profits and shrink the income stream that fuels its war with Ukraine. Can a price cap make a difference? And if so, how?

Oil as an economic engine

Given that it is not possible for the world to completely wean itself off Russian oil, the G-7 recently announced that it is planning to cap the price of Russian oil beginning in December 2022. Its goal is to get more nations to join the G-7 price cap scheme.

The economics of a price cap can be quite straightforward. The escalating costs of an apartment in New York, for example, demonstrate how rent control – a price cap policy – protects renters from the rising cost of housing. When the market rental price, which equates the demand for apartments with its supply, is too high, a price cap below the market rental rate ensures that the price of an apartment cannot legally be higher than the cap.

Squeezing Russian oil profits

Led by U.S. Treasury Secretary Janet Yellen, the G-7 nations in July 2022 decided to cap the price of oil sold by Russia, a policy that is planned to go into effect on Dec. 5. Since this cap would be executed in an international setting with different rules and regulations and with nations whose interests are not always aligned, the success of a price cap is not guaranteed. Even so, the leaders of the G-7 agree that a cap policy is needed to decelerate, if not stop, the Russian war machine.

In addition to ensuring Putin’s war funding is reduced, a cap may help preclude an even higher spike of oil prices. The European Union’s sixth sanctions package is set to ban all Russian crude imports by sea – also set to begin Dec. 5, 2022 – and all refined oil products starting on Feb. 5, 2023. Because the world economy will have relatively little time to adjust to these hard cutoff dates, they are likely to lead to enormous oil price hikes that could cause great suffering in the European Union, the United States and other nations.

If capped at the right level – a little above Russia’s cost of producing oil, estimated at US$40 per barrel – and periodically monitored, then Russia will likely act in its own interest and legally sell oil at the capped price. Potential buyers would not run afoul of Western sanctions if oil is purchased at the capped price, helping to limit dramatic upticks in the price. This is how the price cap concept is supposed to work. Yet a few things could go wrong.

Chief among these is the behavior of nations that are not party to the G-7 cap. China and India, for instance, could decide that they will pay no heed to the cap and simply continue to do business with Russia as they have in the recent past.

But economic forces are likely to make China and India behave consistent with the cap policy.

Since oil can always be purchased at the capped price, China and India have an incentive to reduce their oil expenditures by obtaining even larger discounts from Russia to continue to buy its oil. Since Russia is desperate to find markets for its oil, to continue to do business in these large markets, President Vladimir Putin either has to sell his oil at the capped price or at a negotiated discount. Either way, the intention of the cap, to reduce oil revenues flowing to Putin, will be met.

Some nations might be able to undermine the cap because it would be difficult to enforce. Privately held companies in the business of shipping and financing Russian oil may continue to sell oil to buyers. Such entities, because of the risk of running afoul of Western sanctions, are likely to do so after demanding a cut from any oil sales, and this will, once again, have the impact of cutting into Putin’s profits.

Other forces may help maintain a cap

Another consideration for businesses that ignore the cap is that 90% of maritime insurance is based in Britain and the EU. Such firms will not be able to do legal business with Russian entities or those promoting its interests as determined by the international cap enforcement criteria. Based on my research, I believe that not many buyers will continue to do business with Russia when most seaports, ocean shipping lanes and oil tankers are off-limits to Russian oil because of the terms stipulated in the European Union’s sixth sanctions package.

Putin claims that he will not sell Russian oil to nations participating in the cap program. Based on my research, this is difficult to believe given how dependent the Russian economy is on oil revenue.

Russia’s economy is in poor shape. By one measure, its war with Ukraine is costing about $1 billion per day. Such high costs, in concert with Western sanctions, will continue to have an adverse impact on Russia’s economy. To continue his “special military operation” in Ukraine, Putin urgently needs more revenue.

Oil sales are Russia’s principal revenue source. Perhaps the price cap will pressure Russia to choose selling oil over waging war.

About the Author:

Amitrajeet A. Batabyal, Distinguished Professor, Arthur J. Gosnell Professor of Economics, & Interim Head, Department of Sustainability, Rochester Institute of Technology

This article is republished from The Conversation under a Creative Commons license. Read the original article.

By George Prior

The UK government’s humiliating U-turn on the higher tax rate reforms will not be enough to calm turbulent financial markets, warns the CEO of one of the world’s largest financial advisory, asset management and fintech organizations.

The warning from Nigel Green of deVere Group comes as it is reported that the Chancellor, Kwasi Kwarteng, plans to bring forward his medium-term fiscal plan announcement to this month.

The deVere CEO says: “Mr Kwarteng’s bringing forward of the plan to this month rather than November 23 underscores just how badly the so-called mini budget was received by financial markets.

“Having the announcement sooner rather than later is the right thing to do, as the longer the markets wait for proof that the government’s fiscal agenda is sound, the higher the risk of turbulence.

“However, the bringing forward of the announcement and the scrapping of plans to axe the 45p tax rate stinks of desperation.”

He continues: “The forthcoming amendments to the reckless mini budget that we know already are unlikely to calm markets in a significant way.

“Sterling did regain some ground higher against the dollar and gilt yields fell on the scrapping of the 45p rate announcement, but the pound will remain under pressure and high bond yields remain of serious concern.

“Investors’ trust in UK plc has had a hole blown through it.”

Last week, Nigel Green noted that markets now know where the weakness lies. He added: “If they don’t budge, they will have blown up the UK mortgage market, UK pensions, amongst others, and eventually this could spread to impact the wider global financial markets which themselves are sitting on thin ice as liquidity disappears.”

“Prime Minister Liz Truss and her Chancellor Kwasi Kwarteng have created a loop of doom.

He concludes: “There will be some relief that the UK government finally seems to be listening somewhat.

“However, the modified plans do not go nearly far enough to ease markets and regain economic trust and confidence.”

About:

deVere Group is one of the world’s largest independent advisors of specialist global financial solutions to international, local mass affluent, and high-net-worth clients.  It has a network of more than 70 offices across the world, over 80,000 clients and $12bn under advisement.

By Dan Steinbock 

Not so long ago, Brazil’s BRIC economy soared as working people and the poor were able to join the labor force and formal economy. In just years, a “soft coup” and far-right president derailed Lula’s miracle. What next?  

As I am writing this column, Brazil is preparing for its general election on October 2, after the disastrous term of Jair Bolsonaro, the incumbent far-right president and ex- captain, who placed army officers in key cabinet positions.

Elected in exceptional circumstances, Bolsonaro caused exceptional damage in Brazil’s economy and politics, society and military, and ecology.

With more than 156 million registered voters, Brazil is the second largest democracy in the Americas and one of the largest in the world.

But democracy is no assurance that the election outcome will be democratic.

Bolsonaro’s disastrous term

Rolling back protections for indigenous groups and facilitating deforestation, Bolsonaro compounded devastation associated with accelerated climate change.

Under his government, the COVID-19 pandemic effects were downplayed, quarantine measures opposed, and health ministers dismissed. So, the pandemic has killed almost 700,000 Brazilians; more than in India, despite its seven times bigger population.

Seeking re-election, Bolsonaro is facing former president Luiz Inácio Lula da Silva, a veteran trade unionist, who was elected in 2002, reelected in 2006, and left the office as the most popular president in Brazil’s history. In the past six years, he has overcome not just a throat cancer, but the far-right effort to keep him in prison.

Before the election, Bolsonaro, who has never hidden his yearning for a new military junta, made multiple allegations of election fraud. Observers have been quick to condemn such claims as invalid. But widespread concern prevails that false allegations could be exploited to challenge the election outcome, to execute a coup, or both.

After their bitter experience with military dictatorship (1964-85), the last thing Brazilians want is a junta of generals. Their prime concern is the economy and jobs. And that’s why they want Lula back.

Lula’s Boom, Rousseff’s plunge, oligarchs’ coup               

In the early 1990s, Brazil still had a reputation as the world’s champion in “unfulfilled agreements with the IMF.” In 2003 Lula inherited a poor, resigned nation on the verge of an economic implosion. Winning the presidency heading the left-wing Workers’ Party (PT), his primary objective was to stabilize the economy and to lay foundation for the struggle against poverty.

Lula’s economic policies were born under favorable stars. In 2001, China joined the World Trade Organization (WTO). A year later, Lula initiated Brazil’s economic reforms. To modernize, Brazil needed demand for its commodities; to industrialize, China needed commodities.

In the 2010s, Lula refocused policy momentum to the expanding middle class. Now the goal became to provide new opportunities for the upwardly mobile, while ensuring income transfers to the poorest.

During those boom days, Brazil overtook Italy as the world’s seventh-largest economy, while living standards soared by almost 60 percent. In Brazil, these were the days of wine and roses, or caipirinha and orchids.

Brazil led Latin America. China spearheaded Asia. Both shunned President Bush’s unipolar foreign policy; each supported a multipolar view of the world.

Washington had a different take of such developments.

15 lost years

When Dilma Rousseff, Lula’s chief of staff, won presidency in 2012, she hoped to build on Lula’s success. In this quest, she failed, due to the lack of time and wrong priorities, tax policies and spending.

Worse, international environment worked against her. World trade plunged, commodity prices collapsed, China’s growth decelerated and the Fed initiated rate hikes. “Hot money” began to flee leaving behind asset shrinkages, deflation and depreciation.

In Brazil, a narrow economic elite reigns over an unequal economy polarized by class and race. It had always opposed Lula and PT, and it was supported by external forces. According to Wikileaks, the U.S. National Security Agency (NSA) tapped some 30 Brazilian government leaders’ phones (Rousseff, ministers, central bank chief, etc), and corporate giants, including Petrobras, the huge petroleum conglomerate that would play a central role in corruption allegations.

Sparked particularly by such allegations, protests erupted and were fostered by conservative and family-owned media oligopolies. That boosted the center-right opposition of juridical authorities and military leaders, conservative social democrats, Democrats, and PT’s more liberal allies.

In the subsequent “soft coup,” Rousseff was impeached by the Congress in 2016. The economic effects were disastrous. During Lula’s two terms, Brazil enjoyed a historical boom. Though sluggish rather than stagnant, Rousseff’s period was undermined by the coup. Bolsonaro’s economic mismanagement proved disastrous.

Following the coup and Bolsonaro, Brazil’s GDP is now where it was around 2007 or so. 15 years have been lost (Figure).

Brazil’s GDP: Lula (2003-10), Rousseff (2011-16), coup, Bolsonaro (2019-21)

Source: TradingEconomics; World Bank; Difference Group

Biased judges and political ambitions

In 2015 Sérgio Moro gained national attention as one of the lead judges in Operation Car Wash, a criminal investigation into high-profile corruption and bribery scandal involving government officials and business executives. It fueled Rousseff’s impeachment and Lula’s 580-day imprisonment.

Moro, a Harvard-trained judge, had participated in the U.S. State Department’s International Visitor Leadership Program (IVLP). Meanwhile, Brazil’s federal police began broader cooperation with the FBI and CIA.

Moro portrayed himself as untouchable judge with no political ambitions. Yet, afterwards he eagerly joined Bolsonaro’s government as Minister of Justice and Public Security (2019-20), and subsequently the presidential race only to withdraw after his ratings fell.

There was a reason for Moro’s plunge. His “investigations” were prejudicial. Leaked messages exchanged between Moro and prosecutors have led to widespread questioning of his impartiality during the Operation Car Wash hearings.

In June 2021, all cases Moro had brought against Lula were annulled. White House officials admitted that the CIA and other parts of the US intelligence apparatus had been involved in assisting the “War on Corruption,” which jailed Lula and elected Jair Bolsonaro. Even the UN Committee found Moro biased in all cases against Lula.

Toward Lula’s comeback, unless…

In Brazil’s first round of elections, the candidate who receives more than 50% of the total valid votes is elected. If the 50% threshold is not met, the two candidates who receive the most votes participate in a second round of voting on October 30.

All current polls suggest that Lula will win the first round. The projections indicate he could get 45%-48% of the vote, against Bolsonaro’s 30%-36%. Moreover, all current second-round polls suggest Lula’s win by 10% or more.

Then again…

While Washington has urged Brazil to conduct fair elections, Bolsonaro, after his June meeting with President Biden, issued a coded command to the military in which the word “auditable” focused attention on the electronic voting system.

Brazil’s military has a “parallel vote count,” which some consider a risk to democracy. Furthermore, CySource, a controversial Israeli company hired by Brazil’s military, will presumably “supervise” the election against “disinformation.” Meanwhile, Brazilian observers have charged both YouTube and Facebook for pushing pro-Bolsonaro content and supporting coup mongering.

If democratic rules prevail, Lula is likely to make a comeback on October 2, or October 30. If not, current turmoil is just a pale prelude of what’s ahead.

No election is viable without the “consent of the governed” – not even a democracy.

About the Author:

Dan Steinbock is the founder of Difference Group and has served as research director of international business at the India China and America Institute (US) and a visiting fellow at the Shanghai Institutes for International Studies (China) and the EU Centre (Singapore). For more, see http://www.differencegroup.net 

By Costas Milas, University of Liverpool 

With UK government bonds and sterling both falling hard in recent days, the Bank of England has been forced to step in. Only a few months after it started tightening monetary policy to fight inflation by raising benchmark interest rates and ending its programme to “create” money through quantitative easing (QE), it has made a U-turn.

It plans to create perhaps £65 billion over a two-week period to buy long-dated government bonds to shore up that market, as well as temporarily putting on hold plans to start unwinding its £838 billion of QE money. So will this work?

The specific reason for the intervention appears to be UK pension funds, which suddenly became very vulnerable because of the bonds plunge. This was because pension funds rely on financial schemes known as liability-driven investment strategies or LDIs.

LDIs are essentially an insurance policy to ensure that funds have enough money to pay people’s pensions, even when bonds are paying very low returns. But when bond prices plunged after the government’s mini-budget, funds were forced to find extra money to cover their LDIs. This forced them to sell more bonds and threatened a domino effect where bond prices would keep falling and some funds could have collapsed.

The bank’s intervention has important implications for the wider economy. It comes when people are under increased financial stress because of higher interest rates, climbing energy bills, wages not keeping up with inflation and volatility in the financial markets.

The economy is growing only weakly and may well tip into recession. According to my recent co-authored work, a recession could depress the UK economy for as many as 20 months – longer than the 15 months predicted by the Bank of England.

Stress in the UK markets

These conditions are likely to be an additional reason for the bank’s intervention – despite contradicting its efforts at tightening. Since the interest rates (or yields) on bonds rise as their prices fall, stepping into the market to buy bonds aims to push down these rates.

So far it has worked: yields on UK 20-year and 30-year bonds were both north of 5% before the intervention and are now respectively 4.1% and 3.9%. Since the level of these yields sets the tone for borrowing costs in the rest of the economy, this should encourage more consumer spending and business investment.

Yields on 20-year and 30-year UK bonds

The downsides

The bank’s intervention, without even consulting its Monetary Policy Committee (MPC), is a form of what is known as yield curve control. This is a variety of QE in which, instead of just creating a certain amount of money with which to buy bonds, the central bank wants to achieve a specific yield. Such a policy is mainly associated with Japan, where the central bank has been buying bonds to keep yields at very low levels since 2016.

So far the Bank of Japan has achieved its objective, but the yen has lost a lot of value because the bank is having to create more and more money via QE: it now owns some US$3.8 trillion (£3.4 trillion) of Japanese government bonds, over half the total market. Meanwhile, the yen has virtually halved since 2010, and in recent weeks the Bank of Japan had to act to prop it up.

While Japan and the UK’s moves to control bond yields are somewhat different, the Bank of England intervention is also likely to put additional downward pressure on sterling. It is also going to be inflationary. This shows how unappealing the policy options are at present.

The implications

Will the intervention work? The impact of QE on interest rates is the subject of voluminous research. It is difficult to estimate because it depends on the level of the interest rate, as well as the economic conditions. Things are complicated further because central bank studies find QE to be more effective than academic papers do.

But going roughly by the findings in this co-authored paper of mine, an additional £50 billion of QE purchases in the UK might lower bond yields by 12 basis points (0.12 percentage points). That suggests that unless the bank continues with this new scheme far beyond the current October 14 end date, it is unlikely to have much effect.

Moreover, QE partly works by signalling to the markets that it will keep interest rates low for a protracted period. By setting a time limit and also saying that it plans to return to QT in due course, the bank is undermining its new policy.

Also, the credit ratings agencies may well downgrade UK sovereign debt. They usually reduce a country’s credit score when economic policy uncertainty rises significantly, or debt rises to unsustainable levels, or the quality of governance is on the slide.

We’re certainly seeing a big rise in uncertainty. At the same time, the latest World Bank data reveals that in terms of government effectiveness, the UK is down from the top 7% of countries to the top 13% over five years. What remains to be seen is how UK debt will rise, since we currently don’t have official forecasts following the mini-budget.

With no such estimates due to be published until November 23, not to mention the Bank of England’s failure to consult the MPC, the credit ratings agencies will be seriously tempted to downgrade. Such a move would push UK bond yields upwards again, therefore undermining the bank’s intervention.

It’s worth bearing in mind that the main source of the current instability remains the government’s mini-budget and unfunded tax cuts. This is what undermined investor confidence and caused the sell-offs of UK bonds and sterling in the first place, so the best way to reverse this is to tackle the problem at source by the government modifying its plans.

Having said that, such a U-turn would also leave investors very uneasy about economic management. One way or the other, a rocky economic road looks likely until at least the next general election.

About the Author:

Costas Milas, Professor of Finance, University of Liverpool

This article is republished from The Conversation under a Creative Commons license. Read the original article.

By Bernhard Reinsberg, University of Glasgow and Andreas Kern, Georgetown University 

Everyone from political pundits to people on the street have issued forth on the new UK government’s tax cut-laden growth plan recently. But it was a rare public rebuke from the International Monetary Fund (IMF) that really impacted financial markets.

Days after the government made its mini-budget announcement, the IMF warned that “large and untargeted fiscal packages” could work at “cross purposes” to monetary policy, referring to current efforts by central banks around the world to fight rampant inflation. It also suggested the government should reevaluate its tax measures and provide more targeted energy crisis support at its next budget, currently scheduled for November 23.

Investors responded by beating an even hastier exit from government bond markets and sending the pound plummeting. Within hours of the IMF statement, the Bank of England had announced a plan to try to calm the markets.

The IMF’s decision to comment on UK tax policy was significant and clearly had an impact on traders and investors. And while the uninitiated may be blissfully unaware of the IMF’s existence, it has played a key role in supporting economies in trouble since the middle of the last century.

Upholding global financial stability

The IMF was established in 1944 at the Bretton Woods Conference, which sought to stabilise global finances after the second world war. Based in Washington D.C., it is an international organisation with 190 member states – from Afghanistan to the UK and US, right through to Zimbabwe.

Its mandate is to uphold international financial stability, which it tries to do by monitoring global macroeconomic developments and providing governments with advice and training on economic policy management.

Most importantly, perhaps, the IMF frequently acts as a “lender of last resort” for its members. This means it provides countries in dire financial straits with much-needed money in the form of loans.

In return, these countries must agree to certain austerity measures. Depending on the situation, this can include tax hikes and drastic spending cuts, alongside other substantial economic reforms.

In the last few years, governments in Ecuador and Pakistan, among others, have hiked interest rates, cut back on public spending programmes, and reduced subsidies on household essentials such as fuel and food to meet the IMF’s performance criteria. As a result, the IMF has become one of the world’s most controversial organisations.

Since the performance criteria it uses are based on the IMF’s worldview, the question of whether its advice is adequate, proportionate, and effective is often subject to debate.

For IMF advocates, the sometimes draconian measures it mandates are necessary to restore investor confidence, boost economic growth and help countries become more competitive in the long run. As such, the IMF can work like a seal of approval for a country’s policy plans, helping governments to shore up international confidence in their economies.

To its critics, the IMF has used its policy leverage to advance reforms that have increased poverty and inequality, leaving countries with deep social and political scars for years after accepting its help. For example, during the Ebola crisis in 2014-15, the IMF was criticised for contributing to underfunded health systems that prevented effective government responses to the epidemic.

Moving markets

Regardless, as the recent case of the UK shows, an IMF verdict on government policy proposals can significantly affect financial markets. For countries with immediate financing needs – typically developing economies – restoring investor confidence with an IMF intervention can be critical to the successful resolution of financial crises.

But the IMF has also used its “magic shield” to rescue UK governments from global financial woes in the past. In fact, since the Fund’s creation, the UK has called upon the IMF 11 times.

Its last IMF rescue happened in 1976 when stagflation and political stalemate forced the UK government to ask for a loan to halt speculative pressures on the British pound. The IMF provided not only financial relief, but also stability to a newly elected British administration by helping to calm market nerves about the UK economy.

This time, the IMF offered up its thoughts on the current economic situation in Britain, rather than being invited to intervene. But instead of curbing speculation about the UK’s financial viability, the statement had the opposite effect: markets panicked.

Mortgage lenders continued to pull their offerings and investors kept unloading government bonds, forcing up yields and the cost of government borrowing. Add the plummeting British pound in the mix and the current situation is in danger of becoming a textbook financial crisis.

But the IMF’s assessment is in line with international experts and ratings agencies in doubting that tax cuts will help reignite UK economic growth. Instead, it argues that the cuts will further expand the budget deficit.

Without a sound fiscal plan, this will increase the need for new government debt. At a time of rampant inflation, deteriorating global economic conditions and rising interest rates – which affect the cost of financing for the government – such debts may become unsustainable for the UK.

Taking into account the reaction of market participants to the IMF’s statement, and that the Bank of England felt the need to intervene in the bond market afterwards, the IMF assessment seems to have carried weight.

Certainly, the UK in debt distress is the last thing the world needs. Many governments in developing and emerging markets are struggling to keep their own economies afloat right now while awaiting financial relief from western banks and the IMF.

But the UK’s central position in global financial markets means any panic in the City of London can spread quickly to global financial markets. From this perspective, the IMF’s recent comments about the UK can be seen an attempt to prevent the world from slipping further into a winter of despair.

About the Author:

Bernhard Reinsberg, Reader in Politics, University of Glasgow and Andreas Kern, Associate Teaching Professor, McCourt School of Public Policy, Georgetown University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

By Daniel O’Leary, University of Southern California 

Who will win Nobel Prizes in 2022? Wikipedia posits a handful of contenders for Physiology or Medicine, about 20 different possible winners for the Peace Prize and several dozen potential winners of the Literature Prize. But since the Swedish Academy never announces nominees in advance, there are few insights indicating who will win, or even if the eventual winner is on a given list.

Are there ways to predict the future winners?

The Delphi approach, named after the oracle in ancient Greece, gathers multiple rounds of opinions from a group of experts to generate a prediction. Gambling firms provide betting odds on the likelihood that specific competitors will win. Crowdsourced competitions, such as the Yahoo Soccer World Cup “Pick-Em,” have participants predict individual contest winners and then aggregate the results.

Another approach is a prediction market that provides insight into what people expect will happen in the future by creating a stock market-like environment to capture the “wisdom of the crowd.” Groups and crowds often are collectively smarter than individuals when many independent opinions are combined.

As an accounting and information systems professor at the University of Southern California, I investigate issues related to the crowd both in my research and in my teaching. Here’s how prediction markets harness what the crowd thinks to forecast the future.

The wisdom of the market

In prediction markets, participants buy and sell stocks. Each stock’s price is tied to a different event happening in the future. Information about the future is captured in the stock prices.

For instance, in a prediction market focused on the Nobel Peace Prize, maybe Greta Thunberg is trading at $0.10 while Pope Francis is trading at $0.15, and the stocks for the entire group of candidates add up to sum to $1. The prices reflect the traders’ aggregated beliefs about the probability of their winning – a higher price means a higher perceived likelihood of winning.

Prediction markets have various ways of setting stock prices. The Iowa Electronic Markets took following approach during the 2020 U.S. presidential election:

• Stock DEM2020 pays off $1 if the Democratic candidate wins, and $0 otherwise,
• Stock REP2020 pays off $1 if the Republican candidate wins, and $0 otherwise.

The stock prices capture the probabilities of each candidate winning, in two mutually exclusive events. If the price of DEM2020 is $0.52, then that is treated as the probability of that event occurring – a 52% chance. If DEM2020 is $0.52, then REP2020 is $0.48.

Prediction markets may use real money, or they can use play money. Google’s market used what it called “Goobles,” while the Hollywood Stock Exchange uses Hollywood Dollars. The Iowa Electronic Markets and PredictIt, both sponsored by universities, use real money. Researchers have found that there are no differences in the performance of markets using real money versus those using play money.

Although using play money makes it possible for many people to participate, one potential challenge for prediction markets that don’t use real money is gaining and maintaining interested participants. Despite using different devices to keep up engagement, such as leader boards indicating who has accumulated the biggest portfolio, there is literally no money on the table to keep participants interested in the market.

Participants bring their knowledge to the market

Prediction markets and crowdsourcing do not function in a vacuum.

Researchers have found that information about events finds its way into the prediction processes from various sources. For example, when I analyzed the relationship between the betting odds and the Yahoo Pick-Em crowd’s guesses for the 2014 FIFA World Cup, I found that there was no statistical difference between the proportion of correct guesses in each. My conclusion is that either the crowd’s guesses incorporated the betting odds information or the crowd’s guesses added up to the same result by some other means.

Generally, prediction markets use play money or are run by non-profit universities to study markets, elections and human decision making. Although gambling houses can take bets for many activities, external prediction markets are more restricted in the activities they can be used to investigate, and are typically limited to elections. However, internal prediction markets – run within a corporation, for instance – can explore almost any topic of interest.

Typically, prediction markets function better with informed participants. Although using so-called inside information is illegal in some markets, including the New York Stock Exchange, there generally are no such limitations in prediction markets, or other crowdsourcing approaches. If those with inside information were to participate in a prediction market, it would likely lead to more accurate stock prices, as insiders make trades informed by their knowledge. However, if others find out that a participant has inside information, then they may very well try to gain access to that info, follow the insider’s actions or even decide to leave the unfair market.

The accuracy of prediction markets depends on many factors, including who is in the market, what their biases are and how heterogeneous the participants are. Accuracy can also depend on how many people are in the market – more is generally better – and the extent to which they are informed about the events of interest.

Researchers have found that prediction markets have outperformed polls in presidential elections roughly 75% of the time. But accurate results are not guaranteed. For example, prediction markets did not correctly predict that Donald Trump would win the U.S. presidency in 2016.

Who will be in Stockholm for the ceremony?

In 2011, Harvard University economics faculty had a real-money prediction market site, referred to as “the world’s most accurate prediction market.” The site had been used for predicting the Nobel Prize in Economics, but Harvard advised the site to shut down.

I couldn’t find any current public prediction markets active for the 2022 Nobel Prizes.

For the moment, perhaps the closest to participating in a Nobel prediction market would be to place a bet at one of the gambling houses that takes bets on the Nobel Prizes. Or find a Nobel Prize Pick-Em site, propose such an event to an existing prediction market or build your own prediction market using some of the available software.

If you know of one, let me know, I want to play.

About the Author:

Daniel O’Leary, Professor of Accounting and Information Systems, University of Southern California

This article is republished from The Conversation under a Creative Commons license. Read the original article.