Over the past few months the opinion polls have swung this way and that in the US presidential election, from an initial Obama high to the present situation where, by most reasonable polls, a virtual tie in the popular vote is expected.
The peculiarities of the US electoral system can and occasionally do mean that even winning the popular vote is not enough to win the election, and it is also generally seen that Obama retains an edge there.
As of Thursday the RealClearPolitics poll of polls has the race tied. Opinion polls are fickle creatures — they are always interpretable with a margin of error that can range from 2%-5%; they are dependent on the sample being a representative sample of the likely population, and in an electorate which is as fractured as the US that is not easily guaranteed. They rely on people saying what is truly in their mind and not what they think the pollster wants to hear; and they are dependent on statistical adjustments to make the poll as close to the ideals above as the particular statistician in charge deems appropriate.
They are therefore, and accepted to be, at best indicative. What is nice however is that we can utilise a combination of the wisdom of crowds and people putting their money where their mouth is to get a clearer picture. And that picture, if it is as accurate has it has been historically, tells us that Obama will be returned as president.
Keynes had it right when he noted the market was in some ways akin to a beauty contest in a Sunday newspaper — the object is not to pick the face one finds the most beautiful, but the face one thinks other people will find most beautiful.
Using this approach we can look at real money markets, both betting and futures markets, on the US election.
Let’s look at two, one based in Iowa and the other in Lucan. The Iowa Electronic Market (IEM) deals in political futures, while Intrade is a more traditional betting exchange.
We should note money or reward-based formally structured prediction markets are used in large corporates for research and development& and other uses. Markets exist not just to allocate resources but to aggregate information.
They do this well where a number of conditions can be met: a definite action to be predicted; a clear reward or cost for accuracy or otherwise: liquidity; and a fair trading mechanism.
Moreover, polls not only have a significant margin of error — the margin of error itself is not a good indicator of how accurate the poll may be. The problem lies in that an opinion poll is a static snapshot of voter’s intentions at that time. As such it tells little about how the dynamics will change over time. By contrast a futures or prediction market explicitly forces traders to consider this very issue, in a dispassionate manner.
Technically, the IEM is a futures market. Modern finance theory has achieved a deep understanding about the nature of prices in a futures market. One finding is that the price of a commodity on a futures market is the best predictor of the actual eventual price. During the 2000 US presidential race, for months in advance of the vote, the predictions were consistently in favour of Bush.
The reality was of course different, Gore and Bush being locked in a see-saw struggle. The prediction of the market, especially as the date of the election looms, is substantially closer to the outcome than opinion polls and historically lies within 1%-2% of the outcome.
A further example of prediction markets is betting exchanges. In terms of political markets, one of if not the largest and most influential is the Irish-based Intrade. Other markets such as Betfair and Paddypower offer odds on elections but Intrade is perhaps the largest.
These are liquid markets: as of Thursday there are over 2m trades on Intrade and over £12m (€14.9m) bet on Betfair. As these are essentially the same asset, the winner of the election, the beauty of the market is that the prices, odds of winning, cannot diverge too far from each other. And the results are consistent: Obama to win. On Intrade his odds (Thursday) are 65% and have not been below 50% all year; on Betfair the odds are closer to 70%, while on paddypower.com they are similar. In fact, the historical evidence is that real money markets, such as bookies odds in the pre-1936 US elections indicates that they were astonishing accurate.
However, the remarkable thing about these is that they appear to have good predictive power not just immediately prior to the poll, but in the months prior. Recent research has indicated that the predictive power of these markets is greater than opinion polls held three-four months in advance. And these suggest Obama will win.
* Brian Lucey is professor of finance at Trinity College Dublin
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