Is Too Much Attention Paid to Small InTrade Contracts?

Harvard economist Greg Mankiw recently posted this chart depicting an InTrade contract on the probability of a U.S. recession in 2008, with the following commentary:

In online betting, the probability of recession is now about two-thirds, compared to about one-half a few weeks ago.

Evidence pointing toward a recession is certainly present, as Larry Summers and others have noted. Still, experts drawing conclusions about the economy’s future based on a single InTrade contract may be risky, particularly given that, as of Jan. 8, less than $40,000 had been traded since the contract’s inception, a tiny amount even by prediction market standards (compare that to the over $3.8 million that had been traded as of the same date for “Hillary Clinton to be the Democratic Presidential Nominee in 2008” — you’ll find more analysis of Clinton contracts here and here).

The numbers beg the question: even beyond politics, are we giving too much weight to smaller prediction market contracts? It’s worth acknowledging that in the prediction-market world, an individual betting a few hundred dollars could raise the “likelihood” of an upcoming recession by 20 points.

(Hat tip: John De Palma)