Pooling Our Collective Ignorance Does Not Yield Wisdom

On his risk management blog, back in late July Jim Garvin wrote the following about political futures markets:[I]f 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 are more reliable indicators of the odds of a Bush or Kerry win than surveys conducted by the various media companies. Personally, I feel this level of confidence in unfettered economic markets has reached the level of outbreak in America and Britain previously only witnessed in apocalyptic zombie movies such as Shaun of the Dead (big thumbs up on that film, by the way). On a more analytic level, I find the basic assumption that Garvin uses to support the accuracy of such markets difficult to accept. Simply put, why would anyone believe that the information investors in political futures markets possess concerning the outcome of an election is any better, more efficient, or even any different, from the polling and other horserace information released by large media companies?

On the morning of January 19, 2004, Howard Dean was trading at around 51 cents on the Iowa Electronic Markets, while John Kerry was trading at around 13 cents. Clearly, the market, like many people in the media, still thought that Howard Dean was going to win the Iowa caucus. However, the market was clearly wrong. In the end, Kerry more than doubled Dean's delegate percentage from the precinct caucus. I suppose the collective brilliance of the traders began to shine, however, when Kerry's numbers spiked as the returns began to come in.

The lack of good information is not the only problem with political futures markets. Further damaging their ability to predict is that they have almost no money invexted in them at all. As Barry Ritholtz writes at BOP News (emphasis mine):

Lets compare these exchanges with the U.S. Capital markets, which are, in a word, massive. Total market capitalization for equities are ~$13 trillion dollars; for Federal debt (Bonds and notes) its about $4 trillion; while corporate bonds total in excess of $5 trillion.

The total dollar amount invested is the political futures? An absolute pittance.

Let's start with Intrade.com. They state they are the largest political futures exchange in the world. Their biggest contract - The George W. Bush Futures -- has about two million dollars invested. Over the past year, these futures have traded a grand total of six million dollars. The Iowa Political Futures market is downright tiny in comparison. Over the summer, they had less than $20,000 invested in their "winner take all" exchange.

$20,000? All the Iowa Electronic Futures Market represents is the collective opinion of what literally a handful of investors think is going to happen in the election. This is a sample size that even Gallup would recognize as worthless.

So, not only do political futures markets not predict the outcome of elections, they also do even serve as an accurate reflection of majority opinion at any given time. The only opinions they do reflect are those of a miniscule number of whackos, about whom we know nothing, that have the money to invest in such a bizarre market. I thought I would never write this, but I actually think Gallup is a more accurate predictor of elections than the political futures markets.

Tags: Money (all tags)

Comments

13 Comments

What "political futures" markets show
One way of thinking of them is as a kind of correlate of sports betting, that is as a trailing indicator of the impression that is being created by mainstream media. Assuming that people "investing" in these markets would like most of all to make money on a reasonably sure thing, they are most likely to take their cue from sources that are habitually considered to provide more or less reliable advice.
by egordy 2004-10-03 11:52AM | 0 recs
Political Futures markets are easily skewed
Precisely because so little money is invested in these things, it is easy to skew them with a big bet, if you are willing to take the risk of losing your cash.

Supposing you were a very wealthy B-C 2004 supporter, and you had already donated serious money  to the Republicans.  It would be very cheap to buy good publicity for the Bush-Cheney campaign by placing a big bet on them, either in the Iowa futures, or via Ladbrokes in London, or via other sorts of futures and bookies traders.

Why would you do that?  Because, as we have seen with the behaviour of Survey USA and Strategic Research polling organizations, there is a determined effort to make a Bush victory seem more likely.

Rove et. al are gambling heavily that by making it seem as if a Bush win is likely or inevitable, that they can push the weak media fence sitters, and generally push the climate of informed opinion in their direction.  If Kerry is made to seem as a likely loser, then weak people will not back him, as no one wants to be seen to back a loser.  ((It also creates the right climate for the reception of a Bush victory via massive electoral fraud in Florida and possibly Ohio))

My own view for the last couple months is that there has been a determined effort to throw money at Iowa Futures etc. to this end

by aruac 2004-10-03 11:57AM | 0 recs
Re: Political Futures markets are easily skewed
If that's the plan, it isn't working; Kerry is spiking and Bush is in freefall, presumably due to the post-debate polls.  It seems unlikely anyway -- how many people even know the IEM exists?  And even for those who do, you're only allowed to invest $500 at a time; you're hypothetical rich BC backer would need quite a few accounts, and running them all would be a big hassle, especially since you end up buying contracts in groups of less than ten most of the time.  That $20,000 total does explain why my dropping $200 into it last Wednesday caused visible movement in the Congressional Control and Presidential Winner-take-all markets. If we win both the White House and the Senate (which is the way the trend looks right now), I'll make a 175% profit there.  I stand to make a lot more on Tradesports, especially if one or more of my longshots pays off ($25 each on Bush to lose Arizona, Jim Bunning to lose in Kentucky, and Johnny Isakson to lose in Georgia, and $100 on Jim "National Sales Tax" DeMint to lose in South Carolina, all at odds of ten-to-one or better).
by Alex 2004-10-03 12:26PM | 0 recs
Re: Pooling Our Collective Ignorance Does Not Yiel
[I]f markets are informationally efficient

Ah, the big if.  

These markets are demonstrably inefficient.  For example, there is hypothetical arbitrage.  In other words, if one could somehow buy and sell contracts between say, IEM and Tradesports, you could make money with no risk.  The fact that such arbitrage cannot be taken up (due to the limitations of the markets themselves) points to a rather large inefficiency.  

I think it would be (academically) interesting to have a political futures market that was as large and open as the regular commoditites market.  Then we might have some data...
 

by Scott Pauls 2004-10-03 12:43PM | 0 recs
Re: Pooling Our Collective Ignorance Does Not Yiel
Accurate or otherwise, I stand to make a pretty penny should Kerry pull it out.  I figured that Karry had bottomed out prior to the debate (at about 33 cents) and hoped against hope that he would make serious headway Thursday night.  I guess I was right.  
by swessdog 2004-10-03 01:15PM | 0 recs
To be fair
The IEM should be recognized for what it is -- an educational and research tool on the use of futures markets to harness collective knowledge about real-time events. In that light, there's no necessity for it to be, cough, accurate.

It's a parlor game; I've long run a site (which isn't really online right now, due to other priorities, alas) about the Keys to the White House system developed by Dr. Allan Lichtman of AU. It's been accurate every time I've used it (since 1988), within its limitations (it correctly predicted a popular vote win, but that's the way Lichtman designed the system when he had to resolve the 'stolen elections' of the 19th century). But seeing it as a formal prediction system is probably a mistake. I see it as more revealing of prejudices built into our political system than anything reliably predictive, especially because I see ways happening right now which may be altering the influence (and predictive power) of some of the keys.

This year, it predicts a Bush win. Personally, as much as I've promoted the system over the years, I hope it's wrong!

by Dan Hartung 2004-10-03 02:59PM | 0 recs
My point exactly
On Moneytroop I've written some stuff over the past few days as I've been bombarded by Alan Murray of CNBC quoting Intrade.com's charts showing a huge probability advantage for Bush.

I calculated how little money was actually changing hands on this contract, not to mention when they go to the "Bush Wins Florida" contract, which is even less liquid.

It was funny to see how once they started plugging Intrade on CNBC how the Bush contract shot up dramatically.  Perhaps the DNC could use $100,000 to "correct" this mispricing, and make some money off of Bush supporters at the same time.

by spliffmeister 2004-10-03 03:29PM | 0 recs
Re: Pooling Our Collective Ignorance Does Not Yiel
It's very easy to swing IEM. It'd only take a collective effort of about 25 people to swing the race wildly as it currently is.  The saving grace, is that there is a maximum investment, $200 iirc, so it does limit manipulation.
by Jerome Armstrong 2004-10-03 03:36PM | 0 recs
Re: Pooling Our Collective Ignorance Does Not Yiel
The limit is actually $500, but it would be waste to invest that much, as you'd end up driving the price of whatever you were buying far above the starting price.  One person investing that much and focusing just on the presidential race could probably generate a twenty or even thirty-point shift.
by Alex 2004-10-03 06:32PM | 0 recs
Re: Pooling Our Collective Ignorance Does Not Yiel
If you bother to read the fine print (and I did, once, as part of an online argument) you would discover that IEM is accurate, but not until the last week or so before the election. IEM also underperforms traditional polls if there are more than 2 candidates. And yes, just like any other market (would you like some energy, CA) susceptible to manipulation.. Personally, I think that the entire idea that markets are some kind of wonder tool for predicting the future to be completely absurd, but then that is just my personal opinion.
by bigring55t 2004-10-03 08:02PM | 0 recs
Idea futures markets
On tradesports the Bush 2004 contract has 592,000 contracts out at 10$ each.  

Idea futures markets might not be good for presidential elections, but imagine if there'd been one for CIA analysts in in August 2001?

The price of a contract like "No major terrorist attack in the US before 2002" would have plummeted if the analysts had been playing (The ones who the administration was ignoring).  It'd have been interesting to see how Condi and Rummy would have bet, too - they'd either show they were out of touch, or show they were lying to Bush and the public.  In either case it'd be a record of how they judged the danger pre 9/11.

It wouldn't have need to be real money.  Just give each analyst some play money and have them invest in claims related to their field of study.  After a few years you'd be able to see who was consistently wrong and who wasn't.  You'd also force them to put their cards on the table - there'd be no saying one thing and betting the opposite way, unless you wanted to look like an idiot for losing that play money.

The problem with the Pentagon program, and the reason it got shut down, was simply that they had the sense of the claims wrong - they let you buy shares in "major attack before xxxx date" etc.  That made the public think there would be people rooting for an attack.  They should have had claims like "NO major attack before xxxx date".  That would allow the public to think of them working hard to make those "good for america" investments come true, and ignore the selling short part (since most members of the public don't understand selling short, even though in these markets it's by definition as common as normal buying)

by kochi 2004-10-04 07:52AM | 0 recs
about IEM
Remember that all of IEM's contracts relate to the popular vote.  One pays out the % your candidate gets, the other pays 100 to the winner (no matter by how little) and 0 to the other.  Neither uses EVs though.
by kochi 2004-10-04 07:57AM | 0 recs
Re: about IEM
That is the twist.  I don't know if they were running it four years ago, but if so, the Gore contracts paid off the day after the election; the Florida fiasco was irrelevent to the way IEM operates.
by Alex 2004-10-04 11:48AM | 0 recs

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