Tuesday, October 23, 2012

Election markets take stock of presidential race

If buying shares in an election market sounds like online gambling, that's because it is, says economist Monica Capra. (Emory photo/video.)

By Kimber Williams, Emory Report

Ever wonder how a presidential candidate's stock is trading?

As voters weigh the odds of their candidates prevailing in a close race, an Emory economist suggests that beyond pundits and pollsters, the curious may also consult a lesser-known crystal ball: election markets.

Through election markets, also called prediction markets, voters put their money where their mouths are by buying "shares" that reflect a candidate's chances of winning — essentially betting in an online futures market about the nation's election outcome.

Though rarely referenced by news programs or political analysts, election markets are actually a viable tool that can be used in conjunction with polls and statistical models to help predict election outcomes, says Monica Capra, an associate professor of economics at Emory with research interests in behavioral and experimental economics.

"Basically, the prediction markets are futures markets, exchanges in which people trade asset shares — candidates, in this case — based upon what they believe will happen in the future," says Capra, who teaches about the topic in her experimental economics classes. "The idea that presidential markets can predict election outcomes comes from the fact that markets are aggregators of individual beliefs," she adds. "It's a perfect application for elections — we know when the election will take place and who the candidates are. Trades are made on the belief of who will win."

Election trading typically takes place through online websites, such as Intrade.com, based in Ireland, Betfair.com in England, and the University of Iowa Electronic Markets, where spectators follow the fortunes of their candidates — or other real-world events — by tracking how they're "trading" in the eyes of the public, or bettors.

This week, for example, activity at Intrade.com showed the odds of President Barack Obama winning re-election improving throughout Tuesday night's debate, rising from 61.7 percent before the debate to 64.1 percent shortly afterward — a trend noted on the other sites, as well.

If it sounds like online gambling, that's because it is, acknowledges Capra, who doesn't play the market herself, nor require her students to play it. But as an economist, she does consult it: beneath the profit motive lies a fascinating glimpse into the mind of the American voter. And there can be value in listening to the betting public.

"The fact that there is money on the table gives people more inspiration to gather information and do some homework," Capra says. 

"Markets are information aggregators," she explains. "People arrive with different sets of information and beliefs that are revealed through their trading behavior and captured by the market. That idea is what makes predictive markets work. Basically, it's an economist's crystal ball."

The system works like this: Let's say you want to bet on the likelihood that Mitt Romney will win the 2012 presidential race. You buy "shares" — this week, they're running around $3.66 on Intrade. If he wins, all shares jump to $10 each and you make money. If he loses, all shares immediately plunge to $0 and you lose.

Predictive market sites also post a probability for each candidate winning. This week, for instance, Obama's shares were running about $6.32, which puts him at a 63.1 percent chance of winning. In contrast, Romney's shares were selling at $3.67 each, with a 36.9 percent chance of victory. That can change in an instant.

With websites updating trading around the clock, "it's a market that never closes," Capra observes. However, she offers an important caveat: predictive markets traders don't necessarily represent the average voter. While a political pollster may seek a representative sample of the population, predictive market traders in the Iowa Electronic Market, for instance, tend to be predominantly male, younger, wealthier and more educated than the average voter.

"But as long as you have people informed and motivated to trade in order to make money, that's all you need for the market to work well," she adds, suggesting that traders are more likely to make choices based on solid data rather than emotional impulse when money is at stake.

Capra says she consults predictive markets every day. "Right now, Gallup polls give the edge to Romney," she notes. "But InTrade says Obama will win — his predicted percentage rose both during and after this week's debate. The fact that he did much better in this debate was reflected by people immediately buying shares. The second debate also appeared to stop the upward movement of Romney shares."

So how accurate are online election markets? Though researchers are divided on the topic, Capra says she considers them a valid predictive tool: "As an economist, you have three main sources for predicting election outcomes: forecasting models, daily polls and prediction markets. If I had to choose one, I would choose prediction markets."

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