How political betting markets can predict financial asset prices
they tell you, traders struggle to explain short-term fluctuations in the value of currencies. Recently, however, the pound has become an exception. Every time it seems more likely that Britain will crash out of theThe strength of this link can be measured statistically, thanks to a helpful proxy for the odds of no-deal. On January 16th Betfair, a bookmaker, opened a market for wagers on whether Britain would crash out by March 29th, the original Brexit deadline. Punters have bet £3.6m .
This correlation is robust enough to allow for educated guesses about where the pound might land if Britain crashes out. If the same relationship were to hold in the event of no-deal, there would be a 95% chance sterling would fall from its current price of $1.32 to between $1.08 and $1.18. The most likely value would be $1.13.
The same method can be applied to other markets with strong links to no-deal odds. Among the assets we tested, the biggest winner from no-deal would be gold, with an expected gain of 10%. The worst losers would be domestic British banks, which are heavily exposed to the housing market. For each rise of ten percentage points in Betfair’s no-deal price, the average share price of Lloyds andSurprisingly, the method finds that no-deal would set British and Irish bonds on opposite paths.
One cause of this divergence is that Britain, unlike Ireland, sets its own monetary policy. Facing an adverse shock, the Bank of England can cut interest rates and use quantitative easing, boosting bond prices. The European Central Bank, however, sets policy for the entire euro zone, not just for countries like Ireland that would be particularly badly hit by no-deal.
Our figures are uncertain. Correlations that look robust within a small range of no-deal prices could fail outside it. But unless no-deal becomes more likely, forecasts of its impact require tenuous assumptions. As George Box, a statistician, said, all models are wrong, but some are useful.
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