Best Bet for Next President: Prediction Markets

Going into the Democratic convention this week, most polls of registered voters were showing the presidential race to be a statistical dead heat between Obama and McCain (although today’s Gallup Poll Daily tracking poll is beginning to reflect the typical convention “bounce” that Gallup has observed in most party conventions in recent decades). However, a more reliable indicator of what’s really going on is provided by intrade.com, which trades “all or nothing” futures contracts on a number of different contingent events, including who is likely to be elected the President of the United States. These contracts pay 100 points (where 1 point = $.10) if a specific contingent event occurs and 0 points otherwise otherwise; consequently the prices for these contracts represent discounted, risk neutral probabilities.

According to intrade.com, Obama currently has a nearly 3:2 edge over McCain (which is actually down considerably from the 2:1 advantage which Obama had a few months ago after he became the presumptive Democratic presidential nominee). An important problem with national polls such as Gallup is that these polls are designed to provide an overall snapshot at a given point in time of the nation’s political mood. However, the nation’s political mood doesn’t elect presidents; the electoral college does. While the race may appear to be close nationally, once you do the math state-by-state, you get a very different picture. This information is provided by the intrade political futures contracts, since they represent unbiased bets on the electoral college outcome. While information on overall popularity amongst registered voters is not without interest, the election obviously will come down to who actually turns up to vote, how the undecided segment is swayed, and how all this is distributed on a state-by-state basis. These important subtleties are implicitly captured by prediction markets prices but are completely lacking in the national polling data.

For more information concerning the topic of “prediction markets”, I recommend a Wall Street Journal essay entitled “Best Bet for Next President: Prediction Markets” by Wharton professor Justin Wolfers. Wolfers and Zitzewitz also published the following article in 2004 in the Journal of Economic Perspectives:

Wolfers, Justin and Eric Zitzewitz, 2004, “Prediction Markets“, Journal of Economic Perspectives, Vol. 18, No. 2 (Spring), pp. 107-126.

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