I was on the train today and somebody asked me whether I thought the Fed would raise rates. I said with confidence “they will keep rates the same.”
How am I so sure? Simple. Every now and again I look at the Cleveland Fed’s Fed Funds Rate Predictions page. The Cleveland Fed uses the price of options on federal fund futures to calculate and graph implied probabilities of future Fed Funds rates. Here’s April 23’s prediction of the probability of the outcome of May’s Federal Reserve Board meeting:
From this graph one can see that the markets predict a 95% chance that the Federal Funds Rate will remain at 5.25% after May’s meeting. Therefore, outside of a major surprise, it is highly likely that the Fed will keep rates the same next month.
Numerous other prediction markets exist. For example, the Iowa Electronic Markets predict an approximate 60% probability that a Democrat will win the 2008 presidential election. TradeSports predicts the New York Yankees will win the 2007 World Series. And HedgeStreet allows one to see market-based predictions of upcoming economic events. Wikipedia has a list of markets in their Prediction market page.
Naturally these prediction markets are flawed — they may be illiquid, participants may not have quality information, etc. But, like all markets, they offer the ability for self-correction. If you have strong reason to believe the market is wrong, you can participate in the market and, assuming you are right, help correct its prediction. You just might make a fair amount of money in the process.
Recent Comments