A Word on Political Predictions Markets

It’s strange to see the political predictions markets like Intrade get so much attention recently (see here and here) because, until now, one of the very few people who gave them much attention was…me. As I’ve said before, I don’t place a great deal of faith in these markets, but I think they’re for fun and should be seen that way. (By the way, the top chroniclers of this scene is Chris Masse.)
Let me add a few random thoughts on these markets. The first is that they’re often called “predictions markets,” in fact, I just did, but that’s not quite correct. More accurately, they’re odds setting markets. I’ll hear people say, “Intrade said this will happen, and it didn’t, so Intrade doesn’t work” No, Intrade laid certain odds on an event happening. That doesn’t prevent a longshot from pulling through.
I also hear people say that it just follows the polls. For the most part, that’s true. But not always, and that’s where Intrade can be especially useful. For example, Mike Huckabee’s poll numbers are far better than odds would suggest. Why is that? I’m sure not. Perhaps the market isn’t correct and the Huckabee contract is a good value. Or maybe the market doesn’t see his popularity as lasting very long.
Three years ago, my Nationals got off to a blazing start in the NL East, 50-31 and a 5.5 game lead. They’re odds of winning the division, however, were still very low. The market thought that they would fade, and that’s exactly what happened.
Matthew Yglesias recently made an interesting observation, the markets are pretty boring. He’s right. Day-to-day, it is fairly dull. One thing to remember, though, is that these aren’t stocks, they’re futures. Futures are a strange animal. With futures prices, the underlying volatility can be extremely high, even though the prices can be somewhat stable.
The reason is the dispersion of returns. In others words, a political contract can potentially soar or crumble a great deal in a very short amount of time. I don’t mean just before expiration, I mean at any time. This is also why futures traders are all crazy people. If some candidate had a bad night last night, they’re futures could have fallen dramatically and the market takes that into account.
The price of the futures is the sum total of the odds of very wide-ranging possibilities. Let’s say the McCain contract is at 24 cents. That could be the sum of, say, a 30% chance of going to zero in a week and a 10% chance of going to 90 cents in a week, and many, many others. Unlike stocks, futures are a zero-sum game. If you take from one, you give to another. What would make the futures markets much more exciting would be an options market on the futures, but that would be seriously nerdy. And no one wants that.

Posted by on January 4th, 2008 at 11:18 am


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.