Now that we are on the eve of the midterm election, it is worthwhile considering what the “prediction markets” are indicating. 

In an earlier posting entitled “What are the prediction markets saying about the economy?”, I lay out some of the technical details concerning how the intrade.com market in particular works (there are other similar markets; e.g., the Iowa Electronic Market at the University of Iowa’s Tippie School of Business, but my sense is that intrade.com is the dominant player in this “space”).  The intrade.com contracts are very simple – each contract specifies some sort of state-contingent event, along with a date at which the contract matures.  The payoff is $10 if the contingent event occurs, and $0 otherwise.  Prices are quoted in terms of Intrade “points”, and each $1 payoff is worth 10 Intrade points, so a $10 payoff is worth 100 Intrade points. This way, the market prices resemble probabilities (technically, these are actually “Arrow-Debreu” prices), but for practical purposes, it is reasonable to interpret these prices as probabilities.

Here, I reproduce the Wednesday, 10/28 implied probabilities associated with various political contracts. The GOP House Control contract currently indicates nearly a 90% probability that the GOP will win control of the House of Represenatives. In my opinion, the more interesting contracts are the ones indicating the number of House seats gained by the GOP and Senate Seats held by the GOP.  The current make-up of the U.S. House of Representatives is 256 Democrats, 178 Republicans and one vacancy (256+178+1=435), so if the GOP gains 50 seats (80% probability), it will have a majority of 22 House members.  In the Senate, the markets indicate a nearly 80% probability of 48 GOP seats.  However, given that there are at least two “independents”, this would seem to indicate “gridlock” at the very least!