The idea of relying upon futures markets prices to forecast future events has an interesting history. Nearly 20 years ago, UCLA finance professor Richard Roll published a paper in the American Economic Review entitled “Orange Juice and Weather” which showed, among other things, that the futures market in orange juice concentrate is a better predictor of Florida weather than the National Weather Service. Since the only way one can earn excess profits in a speculative market is to gain an informational advantage over the competition, traders are strongly motivated to try to do just that. If markets are informationally efficient, it follows that market prices represent unbiased forecasts concerning future events. Technically, this means that on average, the market’s estimate of the average value of the event in question is likely to be quite accurate.

Consequently, I believe that political “futures” markets provide reliable indications of the odds that a political party or candidate will win an election.  Although the 2008 presidential election is still more than 3 years away, tradesports.com maintains an actively traded market for futures contracts which pay off $100 in the event that a specific political event occurs and $0 otherwise.  Essentially, prices represent “risk neutral” event probabilities. With this in mind, it is interesting to observe what the political futures markets are telling us at this time about the 2008 election.  Currently, three contracts are traded that involve bets on which party is likely to win the presidency in 2008; specifically, Democrats, Republicans, or none of the above:

Contract
PRESIDENT.DEM2008 (Democratic Party Candidate to Win 2008 Presidential Election) – 48.30% chance
PRESIDENT.REP2008 (Republican Party Candidate to Win 2008 Presidential Election) – 50.50% chance
PRESIDENT.FIELD2008 (The Field (Any Other candidate) to Win 2008 Presidential Election) – 1.20% chance

tradesports.com also makes a market in futures contracts on specific candidates winning either the Democratic or Republican nomination for president.  Currently, Senator Hillary Clinton (D., NY) leads the Democrats (43.7% chance), whereas Senator George Allen (R., Virginia) leads the Republicans (20%).  At this time, it would appear that the Republican race for the nomination is more competitive than the Democratic race; Governor Mark Warner (D., Virginia) comes in second after Hillary with a 10.9% chance, whereas Senator John McCain (R., Arizona) is close behind Senator Allen at 17.2%.  The product of the nomination probability times the party probability listed above represents the market’s best guess at who the next president will likely be.  Currently, the top 5 candidates are as follows:

Hillary Clinton – 21.11% chance
George Allen – 10.10% chance
John McCain – 8.69% chance
Rudy Giuliani – 6.57% chance
Mark Warner – 5.26% chance

Interestingly, the market believes that Governor Arnold Schwarzenegger (R., California) has a better shot of becoming president than the following set of potential candidates: Governor Brian Schweitzer (D., Montana), Retired General Colin Powell (R.), Senator Pat Leahy (D., Vermont), Senator Chris Dodd (D., Connecticut), Representative Harold Ford (D., Tennessee), Senator Joseph Lieberman (D., Connecticut), Senator Elizabeth Dole (R., North Carolina), and Retired General Tommy Franks (R.).  This would quite a feat, since in order for the Arnold to become president, it would require an amendment to the U.S. Constitution (since Arnold was born in Austria).  In other words – not going to happen – not for Arnold, and not for the rest of these “candidates”.