Knowledge @ Wharton (on polls):

The Power of Prediction Markets

The rapidly changing landscape of responders and related technology factors are two reasons why Justin Wolfers, Wharton professor of business and public policy, believes in the power of prediction, or betting, markets. Wolfers &#8212- who is associated with several prediction market sites such as InTrade.com or Tradesports.com [*], where participants buy and sell contracts on sports and potential political outcomes &#8212- argues that prediction markets are a more reliable outcome predictor than polls, for three reasons.

&#8220-First, by forcing you to &#8216-put your money where your mouth is,&#8217- they yield truthful revelation of beliefs,&#8221- Wolfers notes in a paper on pricing political risks with prediction markets. &#8220-Second, markets provide profit opportunities for those willing to gather new information that helps predict the future. And third, markets aggregate information dispersed across many traders.&#8221-

&#8220-You are not asking who they will vote for, but who they think will win,&#8221- says Wolfers. &#8220-The evidence is overwhelming that prediction markets provide a more accurate prediction than polls. On average, the final forecast from a Gallup poll is within about 2.25 percentage points, and the average for prediction markets is 1.5 percentage points.&#8221-

He points out that &#8220-the idea of betting on presidential elections is not new at all. Betting on elections has been going on for the last 100 years. If you read The New York Times from the turn of the century [**], they will report what is in the prediction markets &#8212- called &#8216-betting markets&#8217- back then &#8212- and not polls, which hadn&#8217-t yet been invented. But since 1940, the elections have been dominated by polls.&#8221-

Wolfers predicts that &#8220-within a few years and a couple of election cycles, we will be back to tracking political markets through the lens of prediction markets instead of polls. [***] In fact, in the last few election cycles, we have seen political commentators talking more and more about the race in light of prediction markets.&#8221-

[*] What kind of association is it? I take it that it is an informal association. I have never seen anything written on the InTrade-TradeSports sites.

[**] Thanks to Paul Rhode and Koleman Strumpf. PDF file

[***] I would be more prudent. I&#8217-d say that more and more commentators will follow the prediction markets, but the polls will remain the dominant barometer.

&#8212-

UPDATE: Emile Servan-Schreiber (NewsFutures CEO) comments&#8230-

1) The traders themselves are the first to look at the polls to inform their trades. So the polls are here to stay.

2) Our recent experience in Western Europe seems to indicate that the superior accuracy of markets over polls when predicting elections may be a U.S. artifact that isn&#8217-t so easily reproducible elsewhere. I&#8217-ve discussed this with Forrest Nelson of IEM [Iowa Electronic Markets], and apparently, ever since the Truman-Dewey polling debacle of 1948, U.S. pollsters have adopted a policy of reporting mostly raw numbers rather than projections based on sophisticated secret formulas, so they can&#8217-t be accused of manipulating opinion. However, raw numbers are notoriously unreliable when based on small samples, and Western European pollsters never report them, preferring instead to publish projections based on historically-informed statistical formulas. What we&#8217-ve observed in France and Holland is that it it&#8217-s very hard to beat the accuracy of such projections.