July 15th, 2009
4:52 am GMT

Felix,

I hate to deluge you with comments today but I really have to take exception to this post.

One of the big problems with the financial blogosphere is that a huge part of the conversation takes place at 40,000 feet. Have you ever talked with an investor as a client?? Trust me, no one cares about inner details of financial regulations. No one! Mention M3 or whatever and you’ll put people to sleep. I care and you care, but please bear in mind how inside the bubble we are. This is heads on a needle stuff.

Investors care if stock XYZ in their portfolio is going to go up or down. That’s it. You rarely hear that sort of commentary in the financial blogoshere except with a few high profile names. I, heroically, try to be one source—and I’m the only blogger I of who posts his recommendations to be seen 24 hours a day. That’s far more important to individual investors.

Just take one example. Anyone who’s read my blog knows I’ve been pounding the tables for Nicholas Financial. It’s not a secret at all. I’ve been totally open about it and I own it. The stock is up 120% this year. Yay, I got one right. But here’s the deal: People who have experienced that gain don’t care at all about the Dow 30. They don’t care about Bernanke’s beard. It means nothing to them. When it comes to the concerns of real investors, the most you get out of most mainstream financial bloggers is some tired discussion of EMT. No real person investor cares. I can’t tell you how often I’m asked about basic stuff like how often are dividends paid or does a stock split mean I lose money.

You said that bloggers tend to offer value to the extent they’re influential. No! Dear Lord No! They’re valuable to the extent that they’re good. Period. There’s way too much information and way too little news. The people who get that will thrive. Outside of some short-term bumps, influence has nothing to do with it. Personally, I’d prefer not to be influential. Broader society is heavily biased against stock advisors, so I don’t want to deal with it. Hey, I hope bloggers and Wall Street continue to ignore Nicholas Financial.

The difference is that actionable-type blogs can be held accountable in a way others can’t. Your former boss, Dr Roubini, has said lots of things that didn’t pan out (among many more that did), but he won’t be criticized for his mistakes because he’s a big picture guy. Me? I gotta be right all the time because it’s about the little stuff with hard time deadlines.

You wanna test this? Ask smart well-informed finance people who were some Fed chairs before Volcker, then ask them about the worst stock they ever bought. QED. If anything, the market for actionable advice will grow as more investors abandon full-service firms and head to discounters. This is where bloggers should be.

- Posted by Eddy Elfenbein

Eddy Elfenbein blogs at Crossing Wall Street.

I am publishing this because you can replace “stocks” in the text above by “event derivatives”, and get a good inkling pertaining to our prediction markets.

I written about this topic before but one of the things I find fascinating about finance is how you can use markets for two items to create an “implied market” for a third. This idea is at the root of all the complex financial instruments that caused problems for so many hedge funds recently.

I’ll give you a good example. At InTrade.com, the site where you can trade futures on real world events, you can buy contracts on which candidate will win his or her party’s nomination [*] next year. There’s a separate contract for which candidate will win the presidency [**].

Let’s break out some math, shall we?

If you divide the latter [**] by the former [*], you get an “electability” contract. For example, according to recent prices, Rudy Giuliani has a 41.5% chance (I’m using the last price) of getting the GOP nomination and an 18.4% of winning the presidency. Soooo… the market believes that if he gets the nomination, he has a 44.34% chance of winning (18.4% [**] divided by 41.5% [*]).

(The only minor flaw is that could include a candidate winning but not getting the nomination, however, I’m content with dismissing that possibility as beyond remote.)

What’s interesting is electability in the general election can have little impact on how well a candidate does in the primaries. Some people, myself included, think that Ronald Reagan would have had a better chance of beating Jimmy Carter in 1976 instead of Gerald Ford, even though Ford beat Reagan for the nomination.

I should add that I don’t place a great deal of faith in these real world futures markets. I simply see them as fun games to enjoy, but not to take too seriously. Also, the markets aren’t very liquid. A minor change could have a big impact on the smaller-priced contracts.

Having said that, here’s a look at some candidates and the market’s take on their electability (sorry Paulites and Edwards fan, your candidates were too low to get a useful meaure).

Candidate………To Get Nomination….To Win…………Electability
Hillary……………………..59.5……………….39.0………………65.55
Obama……………………33.0……………….17.2………………52.12
Giuliani……………………41.5……………….18.4………………44.34
Huckabee………………..18.6…………………7.2………………38.71
Romney…………………..18.8…………………5.9………………31.38

As of the last trade, the market believes the Democrats have a 60.2% chance of gaining at least 19.5 seats, and a 46.9% of gaining 24.5 seats. A 60.2% chance is +0.258 standard deviations, and a 46.9% chance is -0.078 standard deviations. So those 5 seats are worth 0.336 standard deviation. Therefore, one standard deviation is nearly 15 seats. The Democrats are now projected to gain over 23 seats, but the market still believes its wide open.