An interesting piece from Brett Arends:
Just Like Stock Markets, Political Markets Can Overshoot
By BRETT ARENDS
January 3, 2008
This presidential election season, political betting markets are a hot topic. Major news sources and other authorites are citing their ability to predict outcomes. The Wall Street Journal has teamed up with Intrade, a political futures market where you can "trade" on candidates' future performance or see how others assess their chances.
It's true, political betting markets, like other financial markets, can be helpful tools for trying to predict the future. And they give a fascinating day-by-day picture of the ins and outs of these extraordinary political races.
Just one caveat: These markets are a long, long way from infallible. Just like other financial markets, they are prone to popular moods and intemperate swings. When pricing houses, or shares in Pets.com, or the prospects of political candidates, the market does not always know best.
Just in the last three months, for example, markets have assessed Mike Huckabee as having (a) no hope of winning the Republican Iowa caucus, (b) a near lock to win it, and (c) none of the above. His chance, according to betting at InTrade, has swung between about 10% and 75%.
Over the same period, Barack Obama's chance of winning the Democratic caucus has swung between 20% and 60% - and has just leapt nearly 20 points, from just over 40% Monday to 59% today.
To be sure, in close and fast-moving races like these you would expect prices to be volatile as fortunes change on the campaign trail. The question is: How much volatility is justified? Would a mature, balanced assessment of Mike Huckabee's chances in the Iowa caucus really have put them at just 10% in mid-October, and at 75% two months later?
Consider other examples of extreme volatility from the campaign trail. Since December 2006, John McCain has appeared to be a runaway favorite to win the Republican nomination with a better than 50% chance, and a no-hoper with a less than 5% chance.
Fred Thompson was given a 35% chance when he jumped into the race last summer. Today it's a tenth of that. And Rudy Giuliani, considered the prohibitive favorite on 47% barely a month ago, has since crashed in the betting to just 28%.
Meanwhile, a few months ago, Hillary Clinton's chance of winning the Democratic nomination was near 80%. Then that collapsed to just above 50%, before turning around again and rising again.
This all makes compelling watching for political junkies. The market prices tell stories and provide important information.
But if they were were truly efficient, surely they would have anticipated Mike Huckabee's groundswell among activists and evangelicals in Iowa long before the more secular media picked it up. But they would then have avoided overestimating it as well, factoring in the former governor's campaign naivete as well as his rivals' willingness to fight back hard.
They would have been much more skeptical of the hype surrounding Fred Thompson earlier on. They would have anticipated that various well-known skeletons would have tumbled out of the Giuliani's closet. They would have questioned John McCain's dominance a year ago, when doubts about him in some Republican circles were well known by experts, but they would never have written him off as finished in July.
I've been writing about political betting markets for years – since I lived in England and wrote a book about sports futures betting, which included political futures. Most of the leading betting exchanges are based in Britain or Ireland, where there is a legal bookmaker on every main street and betting is part of the culture.
These markets consolidated their reputation back in 1992, when the first of them, IG Index, successfully predicted the Conservative Party's stunning, Harry Truman-style upset victory in the British general election. Stuart Wheeler, the founder and then-CEO of IG Index, told me money suddenly started pouring in on the Conservatives the weekend before the voting. By election morning, IG Index was predicting a Conservative victory while every opinion poll put Labor ahead.
In fact the BBC was still predicting Labor to win as the election returns came in that evening.
But there's a twist. Mr. Wheeler told me that back then, a lot of IG's customers were political insiders: Journalists, politicians, and financial traders well connected to the political establishment.
In other words, the predictive power didn't come from that mythical, overhyped force, "the wisdom of crowds." It came from the smart money.
Today, it's a different game. The betting markets have gone mainstream. And most of the money being bet is amateur money – and, in fact, non-U.S. amateur money as Uncle Sam has been cracking down on citizens' Internet gambling.
That's why, for example, these markets fell for the infamous exit polls on Election Day, 2004, that predicted a John Kerry victory. And why, to take another example, they wrote off the prospects of Mitt Romney until quite recently. The markets absurdly cut Mr. Romney's chances of winning the nomination to around 10% in November 2006, just after one of his leading rivals, former Virginia Senator George Allen, had been dramatically removed from contention.
Today these political betting markets give Hillary Clinton around a 45% chance of actually securing her party's nomination and then going on to be elected president in November. Not long ago, the number was 50%.
We don't know who her opponent will be. We don't know if, say, Mike Bloomberg will jump into the race as a well-financed third candidate . And we don't know any of the other things that will happen domestically, abroad, or in political gossip between now and November. Yet the markets, or the crowd, thinks Sen. Clinton's chances of winning the general election are almost equal to the chances of everyone else in the race put together.
That's some prediction.
Markets are fascinating. I'm as absorbed by political betting as I am by the stock market -- right now, maybe, more so. The prices tell stories. They contain wisdom and folly, clues and surprises. Respect them, by all means. But don't revere them. The "crowd" isn't always right.
Brett Arends is a columnist for WSJ.com. His personal finance column, R.O.I., appears several times a week. Write to him at brett.arends@wsj.com
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