In late 2002, Deutsche Bank and Goldman Sachs introduced regular auctions of economic derivatives. These options allow market participants to take positions on a variety of official macroeconomic measures, in anticipation of their scheduled announcement. The statistics covered to date include U.S. Nonfarm Payrolls, Initial Jobless Claims, the Institute for Supply Management’s manufacturing index, the U.S. Retail Report, and the Eurozone Index of Consumer Prices.
The auctions are conducted using a Pari-mutuel Derivatives Call Auction (PDCA) technology developed by Longitude, Inc. The auctions last for between one to two hours and are typically held the day of or one day prior to the actual data release. While the auction is in progress, investors can enter limit orders to buy or sell digital or vanilla options. The digital options offer a $1 payout per contract if the actual release is at or above (for calls) or below (for puts) the strike, while vanilla options offer a payout of $1 per point the actual release is above or below the strike. The available strikes for each auction are determined in advance by the auction sponsors (Deutsche Band and Goldman Sachs). The available strikes center around economist consensus estimates and express a range of possible outcomes for the announced figure.
Using the limit orders received during the auction, the PDCA technology calculates a unique equilibrium price for the various options that will 1) maximize the premiums collected and 2) ensure that the premiums collected will equal the total amount to be paid out for any given actual release number. The equilibrium price of each digital option gives an indication of the subjective probability the market assigns to that particular option expiring in the money and, thus, gives insight into what the market expects the announced figure to be. This figure is called the implied forecast.
As the auction proceeds, auction participants have access to real time information displaying indicative prices and implied forecasts (final prices and implied forecasts are not displayed until the auction has concluded). These figures are updated as the auction proceeds to reflect incoming orders. For example, if an auction participant expects (with high probability) that the released number will be higher than the current implied forecast, s/he may place an order for a digital call option with a strike at or near the current implied forecast. If this order is placed at or above the current indicative price, it will result in an upward adjustment of the implied probabilities above the strike and a downward adjustment of the implied probabilities of outcomes below the strike. As a result, the implied forecast will increase, expressing the revised view of the market taking the latest order into account. Deutsche Bank makes available on its economic derivatives website post auction reports which summarize each auction and the final implied forecast. Appendix I contains some examples of these post auction reports.
Experience with other predictive markets, such as the Iowa Electronic Markets, suggests that the implied forecasts generated by these auctions may prove to be accurate predictors of the officially announced statistics. In this paper, I examine the efficacy of the economic derivatives market in predicting the announced numbers, particularly in comparison to economists’ consensus predictions. Specifically, I examine the following four research questions:
- 1) Do the auctions generate more accurate predictions than those of economists, measured on an absolute basis?
2) If the auction predictions are not more accurate on an absolute basis, are they useful indicators of the surprise in a forthcoming announcement?
3) Do the auctions generate forecasts which are more or less biased than those of economists? and
4) Have the auction predictions improved over time?
Unfortunately, given the short span of time the economic derivative markets have been in existence, there is limited data available and it is difficult to reach conclusions with a high degree of statistical significance. My analysis of the data suggests that the auction forecasts are no better at predicting the actual announcements than economist consensus forecasts. Nor are they useful as indicators of the direction of any potential surprise. Both processes produced forecasts which were, on average, about 0.57 standard deviations from the actual announced figure. However, there does appear to be an interesting result relating to the degree of upward bias in the two types of forecasts. While the auction and economist forecasts both tended to be overly optimistic, the auction forecasts appear to be less so.
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An Examination of the Predictive Abilities of Economic Derivative Markets
