Pursuit of Truthiness

my gut tells me I know economics

What Do Markets Predict About Obama’s Second Term?

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While I saw this a Coke vs Pepsi election with no real differences between candidates, it seems that markets do expect some difference. If you believe the Efficient Markets Hypothesis (which I mostly do), then markets will reflect the best guess that can be made about the future by taking all publicly available information into account.

According to prediction markets, there was a 70-80% chance that Obama would win as of Tuesday afternoon; by Wednesday morning after the election this was 100%. So we can try to attribute any change from Tuesday to Wednesday as representing the effect of a ~25% increase in the probability of an Obama presidency. Multiply the effect by 4 to get the total difference between an Obama presidency and a Romney one. (If you believe the prediction markets. I am still kicking myself for not funding accounts in time to arbitrage between them)

The most obvious reaction has been that the US stock market declined about 1.5% from close on Tuesday to opening on Wednesday. This means people think stocks will be about 1.5*4=6% less valuable during an Obama presidency. It is unclear to what extent this should be interpreted as the economy generally doing 6% worse, as opposed to stocks alone being a worse investment as taxes on capital gains and dividends increase / fail to decrease.

Treasury bond yields decreased slightly, meaning that markets think the government is less likely to default under Obama, or alternative assets will perform worse, or both. I’m not used to calculating the TIPS spread, but it looks like nominal 5 year treasury yields decreased by 4 points more than real yields, meaning a 0.04 percentage point decrease in inflation expectations (meaning overall inflation would have been 0.16% higher under Romney? Perhaps people expected him to appoint Mankiw as Fed chair). On the other hand, gold prices increased ~0.5%. No big differences here.

The biggest difference, and in my opinion the best news, seems to be on foreign policy. Intrade has a prediction market on whether Israel or the US will make an overt airstrike on Iran by the end of next year. This declined from 49% to 37% as the election news came in, suggesting the chance of this happening would have been 4*12+49=97% had Romney won. The chance that China will take overt military action against Taiwan also declined from 10% to 3% on Intrade. These markets are thin enough that I don’t claim they are definitely right, but it is still good to see the chance of war declining.

Comparing the changes in these various markets gives a clear demonstration of what economists have often said– the US President has very little influence over the economy, but quite a bit of influence on foreign policy.

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Written by James Bailey

November 12, 2012 at 7:42 pm

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