Justin Wolfers, Wharton. U.Penn
Eric Zitzewitz, Stanford GSB
Abstract: Betting on elections has been of interest to economists and political scientists for some time. We recently persuaded TradeSports to run experimental contingent betting markets, in which one bets on whether President Bush will be re-elected, conditional on other specified events occurring. Early results suggest that market participants strongly believe that Osama bin Laden’s capture would have a substantial effect on President Bush’s electoral fortunes, and interestingly that the chance of his capture peaks just before the election. More generally, these markets suggest that issues outside the campaign -– like the state of the economy, and progress on the war on terror -– are the key factors in the forthcoming election.
Our idea is a twist on the usual election betting markets. In standard election betting markets, traders buy and sell securities whose payoffs are tied to the performance of a particular candidate. For example, since 1988 the Iowa Electronic Markets have traded securities that pay a penny for each percentage point of the two-party popular vote garnered by each of the major candidates, and these have proven to be accurate indicators. And as far back as Lincoln’s election, there were organized betting markets on the Presidency, and again, these markets were quite accurate.
Our contingent securities are linked to both the election outcome and to specific events that could influence the election. The three new contracts that we listed pay $100 if President Bush is re-elected, AND (respectively):
- Osama bin Laden is caught prior to the election;
- The unemployment rate falls to 5 percent or below;
- The terror alert level is at its highest level (red).
Bettors call this sort of combination bet a “parlay,” and they have long recognized that if the two events in a parlay are not independent, then the pricing of the bet needs to take their interrelationship into account. We can exploit this to learn about what market participants think about the correlation between any two events.
Osama’s Capture Would Hand the Election to Bush
The data on the first contract are the easiest to interpret. At the time of writing, the Osama-and-Bush contract is at $9, suggesting a 9 percent probability that both events will occur. (We are sampling the mid-point of the bid-ask spreads). By comparison, a contract paying $100 if Osama is captured by October31 (two days before the election) is trading for $9.90.
Comparing these prices suggests that if Osama is captured, the markets believe the likelihood of a Bush victory to be 91 percent. (Why so high? The difference between the two prices, which is small in this case, corresponds to the likelihood that Kerry would win despite Osama’s capture.)
By comparison, a contract simply tied to whether Bush is re-elected is trading at $66.60, suggesting that overall, Bush is a two-in-three chance to be reelected. We can also use the Bush and Bush-and-Osama securities to learn about Bush’s chances if Osama is not captured. By purchasing a Bush contract and selling a Bush-and-Osama contract, we get a portfolio that pays $100 only if Bush is re-elected and Osama is not captured. Paying the $66.60, and receiving the $9, yields a total cost of $57.60.
Comparing this with the probability of 90.1 percent that Osama is not captured, this suggests that the markets believe that if Osama is not captured by the end of October, the likelihood of a Bush victory falls to 64 percent. These odds are still good for Bush, but nothing like his 91 percent chance if Osama is captured. It seems to be no exaggeration to state that the election depends more on whether Osama is captured than on any amount of campaign strategy.
A Better Economy Would Help Bush, But Not As Much
…A similar exercise can be performed to compute the effects of a better performing economy on the election.
Unfortunately, the likelihood of an unemployment rate below 5 percent— the contingency our contract depends on –is currently so low that the relevant contract has generated little recent trade. However, if we look to earlier trading in June 2004, it is clear that markets believe that a stronger economy would have given President Bush at least an 80 percent chance to win re-election, well above his overall odds at the time.
Other issues arise if we want to use what we learn from these markets to inform decision making. While other prediction markets have proved surprisingly immune to attempted manipulation, once the stakes become more than academic, the incentive for manipulators will rise dramatically. Once security prices are used for decision making, other traders’ beliefs start affecting their payoffs, and so a trader’s goal can move from predicting what will happen toward predicting what others think will happen. Careful market design can help on both issues, but the issues are fairly complex, and the focus of current study.
We should also emphasize that these results are only experimental. They come from fairly thin, and quite novel, markets. The prices represent the beliefs of a small and possibly quite unrepresentative population of traders, and the financial incentives here are small. They also involve asking people to evaluate small probabilities, which studies suggest many have a hard time doing.
One thing we know about the participants in this market is that unlike political pundits on Sunday television, these participants are putting their money where their mouths are. That feature is what makes market opinions well worth watching.