Alex Tabarrok has a post on the Intrade markets depression contract which indicates that it really isn’t a contract for a depression. Here is the key clause from the contract,
For expiry purposes a depression is defined as a cumulative decline in GDP of more than 10.0% over four consecutive quarters. This is calculated by adding together the published (annualized) GDP figures (as detailed below). If these annualised figures add up to more than -10.0% over four consecutive quarters then the contract will expire at 100.
Alex points to this explanation from Donald Luskin of why this doesn’t quite signal a depression,
The problem is that if you add four quarterly change-figures that are already each annualized, you will get a far larger cumulative result than the actual change over a four-quarter period. Suppose there are four successive quarters each showing an annualized 2.5% decline in GPD. Intrade will add those together and get 10%. But over the year, the annual decline in GDP will acually be 2.5%.
That is quite right. During the Great Depression GDP declined by 8.6% in 1930, 6.4% in 1931 and 13% in 1932. Far larger drops in GDP than 2.5%. Of course, a 2.5% drop in GDP over the course of an entire year would make such a recession a bad recession. Of course, we don’t need 2.5% each quarter for 4 quarters. In the last quarter of 1981, and the first three quarters of 1982 the annualized changes in GDP were -4.9%, -6.4%, 2.2% and -1.5%. Those sum up to -10.6% using the Intrade method whereas actual decline in real GDP over that time was 1.49%.1 So even though the intrade contract is up to 59% it doesn’t mean we are going to see the kind of GDP declines one might normally associate with a depression.
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1All data on GDP comes from NIPA tables 1.1.1 and 1.1.3.
