Michigan, U.S.A. —- Tuesday, January 15, 2008
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The Democrats
The Hillary Clinton event derivative was expired to 100.
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The Republicans
The Mitt Romney event derivative was expired to 100.
Source: InTrade
1. It really was an upset – As it has been pointed out elsewhere, the Clinton victory was a surprise to everyone. Favorites can lose. But so what? Ordinarily, that’s not a market flaw or a reason to doubt the odds shown in the market.
Justin Wolfers article in the WSJ had the best summary:
Against this background, it is no exaggeration to term the result truly historic. Not that there haven’-t been more dramatic upsets or come-from-behind wins that carried more significance —- this was just an early primary, albeit a pivotal one. But in terms of unpredictability, or at least the failure of everyone to predict it, it may have no modern match.
…
Historical comparisons are already being drawn between the New Hampshire primary and the famous 1948 presidential race…Yet the magnitude of the Clinton surprise is arguably even greater…-Thus, Sen. Clinton’-s victory on Tuesday was more surprising than President Truman’-s in 1948.
Given the above, were the Clinton prices on Intrade very far off? It’-s not obvious that they were.
2. Pundits/Critics are NOT traders – If I believe a contract should be trading around 30 and I see it trading at 7, it would make my day. As a trader, seeing a contract that is clearly mispriced is a good thing. Traders who remember the French politician Le Pen’s strong showing in 2002 vs his polls or who read Steve Sailer’s blog should not be surprised that people are dishonest with pollsters. However, to a pundit, an isolated incident of mispricing means the entire concept of prediction markets is faulty.
Since NH results, pundits have been asking, “Are prediction markets flawed?” The traders who make and move the market don’t believe so- they are trading more than ever. In any case, there were no postings on the 7th of January about how wrong the prediction markets are, only after-the-fact postings demonstrating perfect 20/20 hindsight. Traders, not critics, will determine the success of the prediction markets.
Let us not forget that pundits have an agenda too. For some, especially political ones, they need to present themselves as being able to offer insight that no one else has. Since prediction markets allow events to be quantified in real time, the pundits have less to add. This makes critics especially eager to take some of the shine off prediction markets and make themselves look smarter by comparison.
Additionally, there is a contingent of commentators and bloggers with an anti-market bias who delight in seeing any market based tool be wrong. They will be the first to loudly smear PM errors but no where to be found when the market turns out to be right.
3. PMs are not polls – This common mistake is exemplified by this quote from the Chicago Tribune, “The New Hampshire primary was a reminder that prediction markets, where bettors are putting money on the line, can have no more value than opinion polls, where participation costs nothing.” This critic missed the point and doesn’-t realize he is comparing apples and oranges.
Most commentators have focused on the accuracy of the market prices without touching on the underlying purpose of the market: speculation and hedging. Even if the polls are no more accurate than the market, they still can’t be used for trading functions.
4. Regulations have hurt the accuracy and liquidity of PMs – The inconvenience of opening a trading account at Intrade has excluded many Americans from participating. What is the cost of accuracy to the PMs? Surowiecki’s The Wisdom of Crowds lists four factors necessary for a wise crowd: diversity of opinion, independence, decentralization, and aggregation. At least two of these have been highly restricted due to regulations. Even so, the market is usually more accurate than the polls. None of the critics has pointed out that with so many potential traders cut off from trading, the market is surely excluding informed participants.
5. “Serious people who study or work with these markets are not in the ‘-markets are magic’- camp” – Prediction markets are like other financial markets: fat tails, black swans, bubbles, “manipulations” etc. These are all visible in housing, equities, and fixed income markets as well and no one speculates about the end of those instruments. As Eric Zitzewitz pointed out, the “markets are magic” crowd is just a strawman and not a logical basis to attack prediction markets.
Digg Link:
http://digg.com/business_finance/Top_Five_Reasons…-
I like the motto dreamed up by Nigel Eccles and his Scottish team. [I think they’-ll come up with a play-money prediction exchange, but I’-m not sure exactly what they are doing up there.]
And he, too, has come up to the defense of the prediction markets.
[I have updated my list of PM friends. Quite a long list now.]
Author Profile -Editor and Publisher of Midas Oracle .ORG .NET .COM —- Chris Masse’-s mugshot —- Contact Chris Masse —- Chris Masse’-s LinkedIn profile —- Chris Masse’-s FaceBook profile —- Chris Masse’-s Google profile —- Sophia-Antipolis, France, E.U. Read more from this author…-Not his best piece.
I’-m sure he’-ll produce a better piece on Freaknomics, or Marginal Revolution, later on. Or in one of his papers.
Previous blog posts by Chris F. Masse:
Jason Ruspini:
In general, futures markets are “-less futures markets than immediate-past markets”-.
It is hard to evaluate the markets fairly given how difficult it is for someone in New Hampshire to participate in them. Naturally then, the [prediction] markets more easily come to reflect the polls and national media – which were wrong in this case. (Here, the left-leaning media fell in love with Obama, while the right-leaning media happily went about trying to bury the Clinton “-dynasty”-. Consider the tremendously misleading FOX NEWS clip that PoliticalBetting.com linked to over the weekend.)
The legal situation also damages liquidity to the point where these markets are usually manipulated at the margin, as traders with momentum sense a rout and begin to engage in predatory trading, i.e. pushing prices to extremes to force capitulation and/or margin blow-ups.
Dr. Servan-Shrieber’-s comment suggests that these market errors might persist even in modern regulatory regimes like Holland, and corroborates the excellent Erikson/Wlezien paper. Leaving aside the question of significance, Erikson and Wlezien have apparently found a market inefficiency, but since markets can take this into account (they are a “-meta forecasting tool“-), we should expect it to dissipate over time.
Read the previous blog posts by Chris F. Masse:
Why were the political prediction markets so wrong about Barak Obama and Hillary Clinton in New Hampshire?
…-asks Slate’-s Daniel Gross —-via Mister Usability (Alex Kirtland), who needs to go and get his own gravatar.
So, I’-ve been watching the action in one of the political futures markets this evening, Intrade. And the action in this prediction market has reinforced my opinion that these are less futures markets than immediate-past markets. The price movement tends to respond to conventional wisdom and polling data- it doesn’-t lead them.
Throughout the day and into the early evening, while polls were still open, Democratic investors, mimicking the post-Iowa c.w. and polls, believed Obama was highly likely to be the Democratic nominee. The Obama contract was trading in the lows 70s, meaning investors believed he had a 70 percent chance of being the nominee, while Hillary Clinton contracts were in the 20s. […] At 6 p.m., this market had written Hillary Clinton’-s entire presidential campaign off. At 9:30 p.m., it was calling a dead heat. What caused investors to change their minds so drastically in the space of a couple of hours? A few data points that went against the day’-s prevailing conventional wisdom and polls. […]
See also Niall O’-Connor’-s assessment:
I am looking forward to the post New Hampshire Caucus, when all you prediction market advocates crawl out from under your stones. For the record at one point the market on Intrade and Betfair was suggesting that Obama had a 95% probability of winning the caucas- whilst Intrade had him at 77% to win the nomination.A case perhaps of both the foolery of crowds and, the market biting back.
New Hampshire will go down as the Black Wednesday of prediction markets and unless there is now objective transparent debate (as opposed to the usual biased sabre rattling) – prediction markets will be dead in the water.
My answer to Dan Gross’- legitimate question and to Niall O’-Connor’-s snarky comment:
) believe in that.—-
Justin Wolfers:
“In a few years, we may regard the second half of the 20th century as the aberration in which the press used polls rather than markets to track political races,” Justin Wolfers, a business professor at the University of Pennsylvania’s Wharton School, wrote in an e-mail message. “And in the 21st century, we may return to the habits of the early 20th century, reporting on political races through the lens of prediction markets rather than polls.”
Emile Servan-Scheiber:
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’t so easily reproducible elsewhere. I’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’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’ve observed in France and Holland is that it it’s very hard to beat the accuracy of such projections.
[I don’t make mine Emile Servan-Schreiber’s second point, but that’s a minor.]
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InTrade’-s expired prediction markets:
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New Hampshire
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The Democrats
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The Hillary Clinton event derivative was expired to 100.
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The Republicans
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The John McCain event derivative was expired to 100.
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Iowa
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The Democrats.
The Barack Obama event derivative was expired to 100.
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The Republicans
The Mike Huckabee event derivative was expired to 100.
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Source: InTrade
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[A more complete prediction market reporting should have included expired contracts from NewsFutures and BetFair. Sorry for that. Note that InTrade-TradeSports is the only exchange to offer a “closed contacts” section.]
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NEXT: Prediction Markets 101 + Who did best in explaining the prediction markets to the lynching crowd? + After the New Hampshire fiasco, 16 people came to defend the prediction markets, so far. + The prediction markets deserve a fair trial. + Prediction Markets = the greatest time-saving invention of this century
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…- I’-ll alert you to a developing story. [Slate’s Daniel Gross: Why were the political futures markets so wrong about Obama and Clinton?]
Thanks to a friend.
~alex
that Obama and McCain will be the winners tomorrow.
Previous blog posts by Caveat Bettor:
Justin Wolfers in the Wall Street Journal:
[…] Through this process of different people trading based on their own observations about the race, prediction markets prices come to aggregate disparate pieces of information into a single summary measure of the likelihood of various outcomes. Moreover, if this market operates efficiently, it will appropriately summarize all of this information and the price will become the most statistically accurate forecast of the election outcome. […]
If I may, I would like to jot down some thoughts related to my concept of prediction market journalism.
For all these reasons, I can give more than a straight B to Justin Wolfers’- copy. You can do better than that, prof.
In financial markets there is strong evidence to suggest that news gets priced into markets within 15 minutes of its release and sometimes even more quickly. Recent research into prediction markets suggests that they aren’t nearly as efficient with researchers from University of Pennsylvania showing that prices on IEM can be predicted using public news flow.
Doing a simple analysis of some the key events in the 2008 Presidential Elections against prices on Intrade shows that on discrete events there is a clear relationship between prices and news flow. However over longer periods the relationship is not always clear.
On the 4th of March CBS announced the results of a straw poll conducted at the conservative PAC convention in Washington DC. They picked Romney as their favourite. Romney’s price on Intrade lifted immediately where it stayed for about a week.
On the 11th of April the Fred Thompson revealed on Fox News and ABC Radio that he had been diagnosed with non-Hodgkin’s lymphoma nearly three years prior. The New York Times and other publications picked up the story the next day. Looking at his price chart shows he opened on the 12th of April at 19 but then closed at 15. The next day he opened at 11.2 but then closed at 17, as the story died down.
In both these cases, the news stories the media considered to be the important ones correspond with the news flow that traders thought was important.
However, the most interesting market movement of the year must be the Obama August slide. On the first of August Obama opened on Intrade at 35.5 but by the 24th of that month he had slide to 17.2. He continued sliding hitting a rock bottom of 10.7 on the 14th of October.
The question is what was the news flow on Obama from the 1st of August to the 24th of August? Analysing the news articles in the New York Times suggests a disconnect between what was reported and how the market was reacting. Obama started August badly with a bungled comment on use of nuclear weapons.
Additionally, his continued line that stabilisation of Iraq had been a ‘complete failure’ may also have cost him some points.
However in sum these news items don’t seem to correlate with an 18 point slide. This could lead us to two possible conclusions:
Cross-posted from the Hubdub blog.