Monday, November 12, 2007

Bond Prices and World Events

Austen Goolsbee reports on Michael Greenstone's currently circulating working paper in yesterday's NYT. Greenstone's paper is part of a literature that uses publicly traded futures and bond prices to predict world events. One can find all kinds of futures at Intrade, for instance. The data he is looking at, though, is from Iraqi government debt. Greenstone wanted to know the probability of the Iraqi government defaulting on its loans, which he uses as evidence of both the longrun stability of the government, and indirectly a test of the effectiveness of the surge. Though he notes that the surge could be strategically effective without changing the longrun odds of survival. Goolsbee notes that the problem of identifying an effect of the surge on longrun chances of survival are complicated by the current credit problems caused by subprime mortgage lending.

These are the kinds of papers which are hard to swallow when your own subjective beliefs differ significantly from the outcome, and easy to believe otherwise. To the degree that these estimates are unbiased and not clouded by the many events that could be impacting these markets, though, one does have to think deeply about the result.

Another interesting paper, alluded to in Goolsbee's NYT oped, is this Civil War article which used prices on the Confederate government's debt to measure the market-determined probability of a Southern defeat. After the Gettysburg loss, the market downgraded that probability of a loss from 42% chance of success to around 15% post-Gettysburg.

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