November 9, 2004

Political Futures Markets Make the Call in Presidential Election

NEW YORK (HedgeWorld.com)--By and large, electronic trading of political futures instruments accurately predicted the outcome of the 2004 U.S. Presidential election, bolstering the argument that these markets have an edge over polls.

The winner-takes-all market run by the University of Iowa School of Business, one of several run by the school, showed Bush substantially ahead of Kerry throughout September and October. The lead narrowed after the debates but never reversed during the two months.

In terms of the aggregate probability of winning, calculated from the prices of two Republican contracts and two Democrat contracts, Bush reached a high point of US$0.74 in late September, while Kerry went below US$0.33 at that time. Contract payoff is US$1 on the Iowa Electronic Markets, which are designed so that process should predict election outcomes.

The Democratic candidate closed the gap in many polls but not according to traders in political futures. Persistently, Kerry futures remained below $0.50 and Bush futures above $0.50 on the Iowa exchange.

Market Wisdom

While the Iowa markets are used for research by the university, Ireland-registered Tradesports.com is a commercial enterprise. Traders' forecasts were similar, however, with Bush winning over Kerry by 60-to-40 much of the time.

In addition, Tradesports contracts for state vote tallies in the presidential election were on the mark. For instance, in early October Ohio contracts for Bush suggested he would win that state and Pennsylvania contracts suggested he would lose Ohio's eastern neighbor. Ohio was indeed key to cinching Bush's victory, and he lost Pennsylvania.

Proponents of political markets argue that these have better predictive ability than polls because traders are paid for correct guesses and take into account poll results and any other information they see as relevant.

A variety of other political futures are traded on electronic exchanges. For instance, early in the Iraq war, Tradesports offered Saddam-based contracts for those interested in betting on whether the dictator would still be in control by a specified date (see).

Separately, a group in the U.S. Department of Defense wanted to establish a futures market as a way of gaining information about terrorist activities but adverse public reaction to the idea of betting on such events quashed the plan.

Contact Bob Keane with questions or comments at: bkeane@investmentadvisor.com.

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