Using Markets to Inform Policy: The Case of the Iraq War

Justin Wolfers and Eric Zitzewitz

Economica, 2009, vol. 76, issue 302, 225-250

Abstract: Financial market‐based analysis of the expected effects of policy changes has traditionally been exclusively retrospective. In this paper, we demonstrate by example how prediction markets make it possible to use markets to prospectively estimate policy effects. We exploit data from a market trading in contracts tied to the ouster of Saddam Hussein as leader of Iraq to learn about financial market participants' expectations of the consequences of the 2003 Iraq war. We conducted an ex‐ante analysis, which we disseminated before the war, finding that a 10% increase in the probability of war was accompanied by a $1 increase in spot oil prices that futures markets suggested was expected to dissipate quickly. Equity price movements implied that the same shock led to a 1.5% decline in the S&P 500. Further, the existence of widely‐traded equity index options allows us to back out the entire distribution of market expectations of the war's near‐term effects, finding that these large effects reflected a negatively skewed distribution, with a substantial probability of an extremely adverse outcome. The flow of war‐related news through our sample explains a large proportion of daily oil and equity price movements. Subsequent analysis suggests that these relationships continued to hold out of sample. Our analysis also allows us to characterize which industries and countries were most sensitive to war news and when the immediate consequences of the war were better than ex‐ante expectations, these sectors recovered, confirming these cross‐sectional implications. We highlight the features of this case study that make it particularly amenable to this style of policy analysis and discuss some of the issues in applying this method to other policy contexts.

Date: 2009
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (64)

Downloads: (external link)
https://doi.org/10.1111/j.1468-0335.2008.00750.x

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bla:econom:v:76:y:2009:i:302:p:225-250

Ordering information: This journal article can be ordered from
http://www.blackwell ... bs.asp?ref=0013-0427

Access Statistics for this article

Economica is currently edited by Frank Cowell, Tore Ellingsen and Alan Manning

More articles in Economica from London School of Economics and Political Science Contact information at EDIRC.
Bibliographic data for series maintained by Wiley Content Delivery ().