E. Zitzewitz: Price Discovery among the Punters: Using New Financial Betting Markets to Predict Intraday Volatility

July 19, 2006

The migration of financial betting to prediction market exchanges in the last 5 years has facilitated the creation of contracts that do not correspond to a security traded on a traditional exchange. The most popular of these have been binary options on the closing value of Dow Jones Industrial Average (DJIA). Prices of these options imply expectations of volatility over the very short term, and they can be used to construct an index that has significant incremental predictive power, even after controlling for multiple lags of realized volatility and implied volatility from longer-term options.