Scenarios for possible breakup of the European Union have been a lively discussion topic for years. So far the EU is holding together but the possibility of some kind of radical restructuring is always in the background. With the help of a couple of people who may wish to join this conversation, I hope to create prediction markets that produce reasonable probability estimates for various EU events including complete breakdown. These will not be real-money markets but I think they will be useful nonetheless. The purpose of this blog post is to solicit suggestions on how to frame EU breakup (i.e., which tradable propositions or bundle of tradable propositions should we make available to traders) and on the specific contract specifications to use in such prediction markets.
There are at least two difficult issues: 1) defining the time horizon (expiration date) for each contract and 2) defining the criteria for EU failure. Time horizon is tricky from a liquidity perspective, because the plausible failure scenarios all occur at least a couple of years from now- traders usually prefer shorter-term contracts. WRT the other issue, failure criteria, how would we define EU failure? Would it be:
– Germany/France formally withdraws by date X?
– Germany/France resumes use of its own currency by date X?
– X nations formally withdraw?
– Value of the Euro declines below some fraction of the USD?
– UK/other country does not adopt Euro currency by date X?
– Euro currency removed from circulation?
– Repeal of acquis communautaire?
– Formal end of the EU?
– Something else?
So we might have a series of contracts along the lines of, “-German govt formally withdraws from EU by 31 Dec. 2010 [2011, 2012, 2013, . . .]”-
Or we might have a range of contracts (German formal withdrawal, French formal withdrawal, UK non-adoption, etc.). IOW, instead of defining EU failure as a discrete event, we provide contracts on multiple scenarios and traders bet on whichever basket of scenarios they prefer. This approach makes more sense to me than would an attempt to define “-EU failure”- as a single event.
Based on suggestions I’-ve already received, I think the following contracts might make sense:
– Next country to drop out. There would be one such contract, with no expiration date, for each country. All contracts expire when one country drops out (expiration value would be 100 for that country and 0 for the other countries), and would be automatically recreated for the remaining countries. There would have to be a contract provision to handle simultaneous withdrawal by multiple countries, but that shouldn’-t be difficult. And of course withdrawal must be defined precisely.
– Country X adopts/rejects single currency by 31 Dec. 20XX. (Again, “-adopts”- or “-rejects”- must be defined.)
– Germany/France + one other country are last remaining EU members on 31 Dec. 20XX. (”-EU member”- must be defined.)
– Euro currency removed from circulation by 31 Dec. 20XX.
But the above contract ideas are merely first efforts.
How would you define EU failure for contract purposes? What kinds of contracts would you like to see? How to make such long-term contracts appealing to traders?
I much appreciate any suggestions. Thanks.
I would give two suggestions that are somewhat trivial since they might apply to almost any situation. First, try to minimize the number of markets so as to concentrate liquidity. Second, the contract should be as volatile as possible to retain trading interest. (It should be affected by as wide a range of information as possible, unless you are really interested in one of the specific questions.)
What about a market (or ladder of contracts) on the number of countries in EU / using the euro on Dec. 31 2016? This at least partially captures most of your examples above (although it might capture other issues that don’t bear directly to the health of the EU). As a thought experiment, go back to the French referendum of May/June 2005. How would this contract have reacted to that event? (I don’t know.)
Excellent comment, JR.
Thanks, Jason. I agree that these are excellent comments.
This is a great idea, that could increase long-term and sustained interest in information markets. One thought is that not all the countries in the European Union have adopted the Euro currency (e.g. UK). I believe the currency is not as interesting as one or more countries exiting the EU.
Perhaps a series of contracts predicting the number of the current 25 member countries of the EU, ranging from 0, 1-2, 3-4, … to 9+ (or so), that would exit in the timeframe like Jason suggested would be a good construct, allowing for trading strategies involving multiple contracts.