Resources for Readers: Political Prediction Markets

As primary season rumbles along unfailingly toward convention season on the way to Election 2012, pundits and wonks are working around the clock to find sources of information to help them determine where the chips might fall. Increasingly, it appears that the trendy tool of choice for those who cover the political scene is also an excellent example of the wisdom of crowds: prediction markets.

While prediction markets, the topic of this post, are being featured more heavily in national newspapers and nightly telecasts, this is not to say that we are going to start mindlessly plugging the trendy tool du jour going forward. For example, if  the folks at CNN once again decide that hologram technology will assist viewers in understanding election night better, we can promise you won't see anything about it on this page.

Prediction markets, on the other hand, are right in the BlawgConomics wheelhouse. For those who are unfamiliar with the concept, prediction markets allow people to make bets on the outcomes of events. Online platforms of this sort serve as an intermediary between buyers and sellers for everything from weather events to Supreme Court retirement dates and the most pertinent category for this post, political outcomes.

Essentially the more money people place on an outcome (reflecting a belief that it will occur), the more the price increases. As the price rises, owners can then sell their shares and make a profit, or wait until settlement to gain the maximum potential profit. Alternatively, if one were to bet against an outcome that comes to fruition, they would lose money when the bet settles (more on the basics, as well as other strategies, can be found here). The opposite is true as well, meaning that outcomes are always a zero-sum game for participants. In some ways, it can be seen as the ultimate in putting one's money where their mouth (or in this case, clicker finger) is.

All the while, the prices themselves reflect the odds the market is placing on certain outcomes. For example, at Intrade, the most popular prediction market site, an outcome trading at $5.00 per share has, in the minds of the participants, a 50% chance of occurring. At settlement, an outcome that does happen is assigned a value of $10.00 (100%), while an outcome that doesn't occur is given a value of $0.00, which represents its 0% chance of happening. The winners and losers are paid out accordingly. This pricing cum odds determination mechanism is what is getting the political junkies so excited as those prices (up until settlement) presumably factor in all of the best information individuals have about a potential outcome.

While it is true that certain extraneous factors could impact prices of political outcomes more than some other types of outcomes (for example, especially excitable supporters of a candidate betting them up), prediction market pricing does nonetheless provide a snapshot of the best information about races in real time at least as well as the average poll does.

Some of our more imaginative readers might be wondering what safeguards prediction markets might have in place for someone (or their supporters) trying to reverse-engineer a victory by bidding up shares, causing pundits to talk up the candidate's chances in a self-fulfilling bit of hysteria. However, let's all agree to cross that potentially odd bridge when we come to it.

In the meantime, we can all just enjoy the insights that can be had when political junkies and bad gambling problems meet face to face. You can find Intrade's, political prediction page here. We will also post a link to that page in the sidebar, and will leave it there at least through Election 2012.

Those familiar with the site know that this semi-regular segment typically features an academic journal or a web page with free information that one might have to pay for elsewhere. However, today's post feels a little bit different; while the information gleaned from looking at prices there is of course free, there is always a risk that those visiting the site for the 'free' part will end up being enticed into participating in ventures of a more costly nature. Therefore, we just didn't feel right posting this edition of Resources for Readers without including a minor caveat...


  1. So what's the difference between Intrade and an options market? Or is there one?

  2. Good evening Billy Ray,

    As someone with a profound interest in derivatives markets, I suspect that you have already formulated your own opinion with regards to that question. Nonetheless, I fell compelled to respond. Therefore, what follows are my thoughts on the idea that I think you are driving at.

    Depending on how one defines 'derivative', the most straight forward answer to your question is that there really is no difference between Intrade and any other derivatives market. In both cases users are writing contracts based on their prediction of whether or not an underlying event will occur.

    Extending this concept, one could argue that there is no substantive difference between betting on whether President Obama is going to be reelected and writing an option contract based on a theory that a stock might decline in price. Or maybe you would prefer comparing the Obama bet to writing a futures contract based on an orange market report?

    In case someone reading this thinks that I am just playing semantics games to make a point, the lack of a difference really couldn't be any clearer in some cases regardless of how you define derivatives. For example, Intrade offers contracts on Dow prices on certain dates. Contracts to do the same exact thing are some of the most highly traded instruments on futures exchanges!

    So if the contracts on Intrade themselves are akin to other derivatives products on regulated markets, why isn't Intrade treated the same way as the CBOE? The most simple answer is lack of regulatory resources/desire/pressure.

    My guess, and I would stress that this is only a guess (albeit based on assumptions made from following such things over the years) is that for one, some, or all of the reasons above, regulators are simply letting platforms such as Intrade be for the time being.

    As we have argued on this page in the past (notably in our article review regarding Timothy Lynch's 'new paradigm' for defining derivatives), regulators and legislators are aware of these markets, and they are aware of how they operate. It is not like they are shrouded in secrecy. Something I read, if true, supports this; that is that that one cannot use US-bank issued debit or credit cards to open an Intrade account (I haven't verified this personally).

    While this isn't really casting a blind eye, and while it shows at least a de minimus interest by regulators, this clearly isn't the same as blocking access, or regulating the platform outright.

    Why? With the much bigger problems they are dealing with in the financial markets, the relatively small dollar amounts at stake in prediction markets and the fact that Intrade is not a domestic company, it seems probable that the powers-that-be have done a cost-benefit analysis and have decided that the resources/time to shut Intrade down are not worth the payoff. This idea is supported by something else I read about the platform, which is that the CFTC has simply ignored requests for legal clarification of Intrade's status from the company itself in the past.

    Now, this 'allowing by ignoring' relationship could change at any time. Certainly US regulators have thrown their weight around when it comes to online gambling sites, even when they have been housed offshore. If some kind of scandal arose from Intrade, or if regulators decided to flex their muscles a bit, it wouldn't be a shock to see Intrade disappear at least from our shores.

    However for now, while the regulators are away, the wonks will play...