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.