Political futures' chequered past

While as November’s US presidential race will see an ever-increasing focus on opinion polls, past experience suggests that political futures markets could offer a rather more accurate forecast of the election’s outcome. The Iowa Election Markets, a university-run political prediction website, consistently has forecast election winners better than pre-vote polling. Major online trading exchange Intrade successfully predicted the outcome of every state in the 2004 presidential election, even when opinion polls an analysts were forecasting a John Kerry victory.  While in Florida, numerous polls showed Senator Kerry leading, or the state too close to call, betting markets consistently showed President George Bush winning comfortably.

Political prediction markets allow individuals to take positions on the outcome of future political events. Intrade currently shows a price of 68.0 for Senator Barack Obama to win the the US presidential race, and 31.5 for Senator John McCain – meaning betters cumulatively believe there is a 68% chance of Obama winning and a 31.5% possibility of McCain emerging.  They are willing to pay 68 dollars for a contract that will pay 100 dollars if Obama wins, and 31.5 dollars for a contract that would pay 100 dollars if McCain wins. Traders do not have to hold contracts until the result of an event is known, and can trade out at any time, taking a profit or loss depending on price movements.

Political futures markets are gaining attention because of an increasing view that they draw on the cumulative views of a large number of traders. While election opinion polls generally ask individuals who they will vote for, or who they would like to win, in political prediction markets, traders are asked who they believe will win.  This is meant to remove a great deal of partisan and emotional bias out of political calculations. Such markets are all the more dispassionate because traders are required to back up their views with real stakes.

Moreover, in assessing election outcomes, political futures markets arguably complement opinion polls, particularly given that poll data may well be an important source of information on which trades are based.

Possible drawbacks

This is not to suggest that political futures markets are not without potential and real drawbacks. Like other markets, they are at risk from speculators -- though Intrade and other companies seek to limit their influence by, for example, limiting the size of positions traders can take.  For example, while an Obama victory at the end of last month was trading at 52.3 on Intrade, it was at 61.7 on UK-based futures and gambling site, Betfair.  This suggests that Obama contracts were being sold short on Intrade, thus distorting the market. This effect can be magnified by what investor George Soros described as ‘reflexivity’ –- the power of market speculation not just to predict an outcome. but to affect it. Heavy betting on a candidate might make them seem more popular, and thus more electable in primary races.

Betting markets are relatively ‘shallow’ – small sums are traded, by comparatively small numbers of participants.  This makes large fluctuations more likely, undermining markets’ predictive power, and makes manipulation an easier prospect. By limiting the sums which can be traded, too, exchanges are limiting the potential loss to investors and encouraging them to act in a riskier fashion.

Certainly, the markets’ much-vaunted track-record can be exaggerated, since their success is often framed in relative terms, compared to notoriously fickle polls. Political futures markets predicted Kerry’s defeat in 2004, but they also missed his emergence in the primary campaign – a sign that ‘conventional wisdom’ can emerge among traders as well as pundits.

For the traders themselves, there is an additional risk. Contracts occasionally do not have verifiable outcomes, which can lead to disputes.  For example, in mid-2006 there was a problem with contracts on the site Tradesports on whether North Korea would successfully fire ballistic missiles that would land outside its airspace.  While the North Korean government claimed to have taken such a step, and it was reported in international media, Tradesports disputed the position because the contact stated that the US Department of Defense had not confirmed it.  This led traders to argue that this response was not credible because it was not an impartial source.  If individual races go to the courts as they have in the past, such problems could emerge in the political sphere, too.