As President Bush rattles the sabers of war, pundits have been quick to sum up the costs of America's war chest. Yet, new research from Stanford's Graduate School of Business suggests that the experts are missing the mark. The study estimates that the threat of war has already caused the U.S. stock market to shrivel $1.1 trillion since last September, and when the bombs start to rain on Baghdad, America's wealth may shrink even further.

The paper, co-authored by Justin Wolfers and Eric Zitzewitz of Stanford's Graduate School of Business, and Andrew Leigh, a doctoral student at Harvard's John F. Kennedy School of Government, examines the impact of the looming war on oil prices, the economy and the stock market. To gauge the financial market's reaction to such impacts, the three researchers used a novel financial instrument ­ the Saddam Security ­ that is traded on an Irish-based online exchange at www.tradesports.com, which pays $10 per share if Saddam is ousted by June 30, 2003. The security's price indicates the market's estimate of the probability of war at any given time. Using trading prices, the authors examine how the market responds to daily increases and decreases regarding the risk of war.

The study's findings

Oil prices: As the probability of war increases, oil prices rise, indicating that the market estimates that war raises oil prices by $10 per barrel in the short term. Oil futures, traded on the New York Mercantile Exchange, indicate that the oil price disruption is expected to last about 18 months and that war may lead to slightly lower oil prices in the long run. However, the authors estimate that any "oil dividend" of war with Iraq would be fairly modest ­ a one-time benefit of an average $250 per person in the United States.

Stock market: Using Saddam Security prices to measure the probability of war, the authors estimate that waiting for war has already reduced the S&P 500 by 15 percent since September 2002, or the equivalent of a $1.1 trillion loss of wealth when compared with a no-war alternative. This decline reflects the market's average expectations concerning the cost of war. Delving deeper, they find substantial uncertainty about the likely cost of war, including a 70-percent probability that the eventual effect of war on the market will be a decline of 0-to-15 percent, a 20-percent probability of a 15-to-30 percent drop, and a small but significant 10-percent probability of a catastrophic plunge in excess of 30 percent. Which scenario will actually occur will likely unfold during the coming weeks, they argued.

"What this means is that by mid-March, about 95 percent of the war's effect on the U.S. stock market has already been priced in and $1.1 trillion of the nation's wealth has disappeared," said Wolfers, an assistant professor of political economy at Stanford Business School. "From here on out as the war unfolds, there's a 70 percent probability that the market will rally a bit ­ say, the war goes better than expected ­ but there's a 30-percent probability that we're on the verge of another drop, which could be steep," warned Zitzewitz, an assistant professor of economics.

Industry sectors: Blows to the U.S. equities market are concentrated in the consumer discretionary, airlines and information technology sectors. On the other hand, the researchers argued that war bolsters the gold and energy sectors. Surprisingly, benefits for the defense industry are somewhat muted, they said.

Other countries: Analyzing the response of stock markets in 44 other countries, the authors find that nations most likely to be adversely affected by war in Iraq are the major oil importers, or are tightly enmeshed in the world economy. "Those hardest hit by the war include Turkey, Israel and several European nations," said Leigh.

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