We have witnessed unprecedented betting volume on the Intrade political markets. Perhaps more interesting has been the sharp price swings. Some have attributed these changes to a “rogue trader” who is seeking to slant prices away from their fundamentals. This charge could prove a serious concern in the ongoing debate to legalize these markets in the United States.
What is often forgotten in these discussions is that betting on elections is hardly a new concept. Election betting has occurred in the US since at least the 19th Century, and even earlier in England and Italy. In the US betting became centralized in organized markets outside of Wall Street in the early 1900s, and newspapers reported the current prices and even individual wagers on their front pages (see images above).
My co-author Paul Rhode and I have documented the existence of these markets and have analyzed the time series of prices and bet totals.
These markets provide several lessons for the present experience. First, the historical markets had a very strong forecasting record. In the fifteen presidential elections between 1884 and 1940, the underdog in mid-October won only once (in the closely fought 1916 election). This suggests giving credence to the current markets, despite the occasional price gyrations.
Second, volatile prices were common in the months leading up to the elections in the historical markets. At the same time, they tended to rapidly move in favor of the favorite in the last few weeks before the election (likely reflecting the diminished chance of an October surprise which would change the leadership in the contest). So the recent strong shift towards Obama in the political markets is nothing new.
Third, they show that these markets do more than simply mimic polls. This must be true since scientific polls simply did not exist during the existence of the historical markets.
And finally, they help support the case for legalizing these markets. It is sometimes argued that political futures markets might be subject to manipulation by political partisans which in turn might influence election outcomes. Although large sums of money were at stake in the historical presidential betting markets, I are not aware of any evidence that the political process was seriously corrupted by the presence of a wagering market. Many current concerns about the appropriateness of political prediction markets are not well founded in the historical record.
Further reading:
Rhode and Strumpf (2004). "Historical Presidential Betting Markets." Journal of Economic Perspectives.
Rhode and Strumpf (2008). "Historical Political Futures Markets: An International Perspective." working paper.
Slate, "When Wall Street Bet on Elections." 26 September 2008.
12 comments:
edster: I think that while it is true that the markets aggregate information from a wide variety of sources, it must be said that polls are one of the strongest information sources out there. I am pretty sure that without polls, the data on intrade would be much less accurate as the traders would have less information to use.
scaramouche said :
I am the hemp fandango. Get hanged, buddy!
MadMaxx said :
The way the intrade market quickly responded to the polls when McCain took a brief lead in the polls after the Rep. National Convention leads me to believe the polls are a big factor in prices.
Oskar Lange said :
What has happened since 1940?
Koleman Strumpf said :
Oskar:
Good question! The markets in part disappeared due to the rise of other forms of gambling. Newspapers also significantly dropped their coverage of the markets, preferring to instead discuss polls.
Rouge Trader said :
How do you define “rogue trader”
Alleghany said :
Rouge traders are traders caught red-handed making huge profits!
Rogue traders are traders caught wearing rouge!
Big WIlly said :
I like chees.
Los Arcos said :
Though political futures markets provide an interesting mechanism for price discovery, I don't see what other social purpose they provide. If you let market players take positions large enough to hedge their "exposure" to a particular candidate (say, an arms manufacturer hedging the risk of the Republicans losing the White House), you also create an incentive structure for manipulation of the democratic process. How are we served by the creation of financial incentives for shenanigans as "harmless" as fraudulent news stories to those as serious as political assassinations?
Alleghany said :
Los Arcos, all markets provide the same incentives you are questioning. Anyone who is short Apple stock has a financial incentive to assassinate Steve Jobs. How is Intrade different? IMO the public good through unbiased information and the price discovery role far far outweigh the potential negatives. And speaking of biased news stories, Intrade is what it is because people trust it, often much more than pundits and journalists who inevitably carry their own biases and loyalties into their work of 'informing' the public. I'll take the intrade electoral map over a fox news update 10 times out of 10.
Los Arcos said :
Alleghany, just because other markets provide the same incentives doesn't mean that they don't have other benefits. I wasn't questioning the social purpose of public markets for the trading of equity shares. Intrade is much more comparable to sports betting than to a stock market.
That said, I'm a big fan of price discovery and I acknowledge the helpfulness of alternative sources of information, especially in the political process.
No one said :
Arcos and Alleghany, Intrade seems like a penny stock market to me. All the market microstructure is there, but the bid/ask and volume is still too low (except perhaps in the most liquid contracts) to avoid "pump and dump" scenarios, such as we see with those crazy newsletters I get in the mail touting a penny stock with the "next big thing in solar." Surprise, surprise, it has been moving up slowly on low volume. Then it spikes when people read the newsletter, and the informed/shady prior owners get out. Imagine if you were a staffer for Kathleen Sibelius prior to the Biden pick. You'd have an incentive to pump and dump your boss's odds on Intrade. But a deep enough market would have *other* informed traders (eg Biden staffers) shorting the hell out of your Sibelius contract.
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