Sunday, December 18, 2011

Could the "wisdom of crowds" be wrong on France downgrade?

Intrade generally represents an efficient market with thousands of participants placing bets on various events - what is sometimes referred to as "wisdom of crowds". That is why it is quite surprising that Intrade has the probability of France being downgraded by June 30th, 2012 at only 67%. This probability should be in the 90s.

The rules are clear - it takes only one rating agency to pull the trigger before next summer and the contract settles at par.
  • This market will settle at $10.00 if either Moodys, Standard and Poors or Fitch announce they have downgraded the long term credit rating of France below AAA.
  • This market will settle at $0.00 if neither Moodys, Standard and Poors or Fitch announce they have downgraded the long term credit rating of France below AAA.
  • This market will be settled using official statements from Moodys, Standard and Poors or Fitch regarding the downgrading of France's credit rating, as reported by three independent and reliable media sources. Please note that only one of the rating agencies needs to announce a downgrade for this market to be settled at $10.00.
But the rating agencies all but told us the downgrade is coming. Here are the two warnings.

Warning #1:
Standard and Poor's: 
France (Republic of) Sovereign Credit Rating AAA/Watch Neg

Depending on the score changes, if any, that our rating committees agree are appropriate for each sovereign, we believe that ratings could be lowered by up to one notch for Austria, Belgium, Finland, Germany, Netherlands, and Luxembourg, and by up to two notches for the other governments.
Warning #2:
Fitch: Fitch has also revised France's Rating Outlook to Negative from Stable. While France's 'AAA' status is underpinned by its wealthy and diversified economy and financing flexibility, the Negative Outlook reflects heightened risk of contingent liabilities to the French state arising from the worsening economic and financial situation across the Eurozone.
At 67% odds, it looks like easy money - there is very little doubt France is getting downgraded.  But back to the "wisdom of crowds" and the predictive markets. What this is telling us is there is (highly surprising) a significant portion of the market - a third to be precise - that is holding out hope that France will not get downgraded in spite of the rating agencies' open warnings. They will be thoroughly disappointed.

Note:  With regard to US citizens trading contracts on Intrade, the internet gambling prohibition makes it illegal to operate a gambling website in the U.S. but it has no restrictions/penalties on clients.
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