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# Intrade and the Dow Drop

2 01 October 2008 03:12AM

With today's snapback, the Dow lost 777 and regained 485.

As of this evening, Intrade says the probability of a bailout bill passing by Oct 31st is 85%.

(777-485)/(1-.85) = 1,946.  So a bailout bill makes an expected difference of 2000 points on the Dow.

Of course this is a bogus calculation, but it's an interesting one.  Not overwhelmingly on-topic for OB, but it involves prediction markets and I didn't see anyone else pointing it out.  I hope the bailout fails decisively, so this calculation can be tested.

PS:  Bryan Caplan understands Bayes's Rule:  It's not possible for both A and ~A to be evidence in favor of B.  So which of the two possibilities, "unemployment stays under 8% following a bailout" and "unemployment goes over 8% following a bailout", is evidence for the proposition "the bailout was necessary to prevent economic catastrophe", and which is evidence against?  Take your stand now; afterward is too late for us to trust your reasoning.

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Comment author: 01 October 2008 04:30:11AM -1 points [-]

You are hereby forbidden from talking about the Dow ever again. The S&P 500 weights 500 constituents by their market cap; the Dow weights 30 random-ish constituents by their PRICE. IBM's weight in the Dow is 4.5 times that of GE because it had a couple fewer stock splits over the years or issued fewer shares; in the S&P its weight is, correctly, about 60% of GE's, because it's a smaller company. The Dow is what crazy people talk about on CNBC.

Also, Intrade should list the conditional futures---S&P price with bailout, S&P without bailout.

Comment author: 01 October 2008 04:46:49AM 0 points [-]

Nice post Eliezer. Fascinating, really. It would be very interesting to see this theory tested.

Though one problem is that you assume that Monday's close + 777 is the "neutral" starting point. Despite the fact that the bailout proposal wasn't made public nor finalized until Sunday night, we can expect the market to have anticipated some form of bailout with some likelihood of passage long before Monday. So we'd have to go back a bit further.

Comment author: 01 October 2008 04:50:48AM 0 points [-]

Not overwhelmingly on-topic?

So we have a small minority of financial wizards and their supporting frameworks convincing everyone that they can take an overwhelmingly, inhumanly complex system and quantify the risk of ALL scenarios. Then when this is proven out as hubris, the broader system appears to exhibit cascading failures that impact direct and non-direct participants. The given leaders with vast resources could essentially flip a coin on the post-hoc solution, biased by the proximity of their next election.

So yes, MBS's aren't active agents with goals, but their caretakers with profit-maximizing motives are. Should we have better engineered the macro-system or the mortgage backed securities?

Maybe we need a Friendly Mortgage Securitization project.

Comment author: 01 October 2008 07:07:13AM 0 points [-]

"I hope the bailout fails decisively, so this calculation can be tested"

Comment author: 01 October 2008 09:41:29AM 0 points [-]

Note Post Scriptum above.

Comment author: 01 October 2008 10:22:30AM 0 points [-]

I hope the bailout fails decisively, so this calculation can be tested.

I take it you believe the consequences of the bailout failling are mild, and that the extra information we have on the accuracy of the Dow would compensate?

Comment author: 01 October 2008 10:59:49AM 0 points [-]

Amazing: "Googleâ€™s stock was hit by what appears to have been massive "erroneous trading" that caused the stock to drop from a \$380 Monday close to as low as \$25.80 in late Tuesday trading." - Google stock plunges more than 93% in "erroneous trading"

Comment author: 01 October 2008 03:33:49PM 0 points [-]

Comment author: 01 October 2008 03:47:37PM 0 points [-]

1) Eliezer_Yudkowsky: You should be comparing the percentage (1) change in the S&P 500 (2) to the change (3) in probability of *any* bailout happening (4) over the days in which the changes occurred (5) and have used more than one day (6). There, that's six errors in your calculation I count, of varying severity.

2) Tim_Tyler: Yeah, I'm surprised that hasn't been posted on Slashdot yet. I want to be the first to propose the theory that United Airlines was behind that, since Google was the cause of a recent fake plunge in United's stock price, when they highly ranked an old story about United's bankruptcy, fooling some into thinking it was happening again and they need to sell. Okay, maybe not "cause", but they started the chain reaction, and United blames them.

3) Peter_McCluskey: Whoa whoa whoa, are you now admitting that measuring the correlation between InTrade contracts and financial variables over a *succession* of days rather than a single day is important?

Comment author: 01 October 2008 05:21:43PM 0 points [-]

Your calculation neglects the issue of timeliness. You assume that all the expected damage to firm profitability took place as a result of the movement of p(passage by Oct 31) from 1 to 0.85.

I don't think that this is the relevant event. The flow of credit is frozen now, and every day that this blockage remains in place causes further damage to the Economy and increases the odds of a Keynesian Death Spiral.

The bailout's defeat shifted p(Passage in the next few days) from something pretty high to 0, while decreasing p(passage by Oct 31) by a little. In my view, the markets were primarily reacting to the former adjustment.

Comment author: 02 October 2008 08:50:50PM 0 points [-]

Please take this discussion and these insights to www.cnbc.com and challenge some of the bogus reasoning that is passing for journalism there.

The claim made here http://www.cnbc.com/id/26977132 demands intelligent dissection.

Email fastmoney-web@cnbc.com and tell them why a statement like this...

As you can see from the chart, â€œthereâ€™s big volatility in this market and big volatility never happens in the middle (of a cycle). By all accounts big volatility only comes at the top or the bottom,â€ Worth says. And this certainly isn't the top.

...is nonsense. And that Worth should be challenged to provide a ton of references to back up his claim.

Comment author: 05 October 2008 01:03:00AM 1 point [-]

It seems relevant to the above post that the market reaction to the bailout passing on Friday was decidely negative.

Which puzzles me.

Comment author: 05 October 2008 04:08:03AM 1 point [-]

Agreed. I didn't expect that, I can't explain it, and I relinquish my theory.