TCS Daily

Snow Job

By Josh Hendrickson - February 15, 2006 12:00 AM

"There is no such thing as a five-day forecast. If there was we would only get it every five days."
- Jerry Seinfeld

The Chicago Mercantile Exchange (CME) has announced plans to offer futures contracts for seasonal snowfall in New York City and Boston. Investors, companies, and local governments will now bid on contracts predicting the snowfall in each city in an attempt to make money and manage risk. The announcement is exciting not only for economists, but for people who wish to have accurate estimates of snowfall.

Markets can be better predictors than individuals. James Surowiecki calls this "the wisdom of crowds". In his book by the same name he explains that market wisdom is the result of each independent person's information. Markets help to summarize these diverse opinions as "one collective verdict."

Evidence of this wisdom is found in the fact that prediction markets are now widely used and have successfully determined the outcomes of everything ranging from the 2004 election to Martha Stewart's trial, despite conventional wisdom to the contrary.

Futures markets can reflect the wisdom of crowds. And today they allow those directly affected by the fate of a commodity to hedge against losses. For example, an orange grower in Florida may fear that hurricanes will destroy his crop and thus he will buy a futures contract on oranges, betting that prices will go higher. If the supply of oranges is significantly reduced, the price will go higher and even if the grower loses a great deal of his oranges, he will have minimized his losses.

Weather futures have not been around for very long. Temperature-index weather futures began being traded on the CME in 1999 and the snowfall futures will begin trading at the end of this month. Time will tell if these measures will provide accurate forecasts, but there is reason to believe that they will be useful tools nonetheless.

City governments would like it if snowfall were low because they would not have to spend the money to have the roads plowed and salted. Ski resorts, on the other hand, would prefer to have a lot of powder for their customers. Nevertheless they could each bet that they would experience bad fortune in order to minimize their losses. And these attempts to hedge against misfortune could ultimately lead to better forecasts.

These markets are an outgrowth of a trend already underway the business community. Companies whose business is directly influenced by changing weather have gone to great lengths to hire meteorologists and use supercomputers to make predictions. The difference between this meteorologist and your local weatherman is the fact that if the meteorologist is wrong, he may be out of a job -- whereas local weathermen tend to be fired for stammering or a bad moustache. Additionally, companies often pay more than double what any top meteorologist could earn elsewhere in order to attract the best candidates for the job. These incentives are likely to significantly improve performance.

Who knows, soon you may be checking the weather forecast at the Chicago Mercantile Exchange rather than on your local news.

Josh Hendrickson is a writer in Ohio. He maintains the blog entitled "The Everyday Economist".


1 Comment

Meteorological metaphors
This only reinforces my belief that all TV meteorologists have their 'batting averages' computed, like baseball players, and hung around their necks while on camera. Public shaming is the best cure. Bookies could then do a brisk business betting on the winners and losers.

TCS Daily Archives