Prediction Markets on the Veep Race

Here’s The New York Times shortlist for the vice president. Here’s a similar list from the Wall Street Journal. But there are some bigger differences of opinion with political prediction markets, which I reviewed in my latest Wall Street Journal column. Let me give you the highlights.

First, on the Democratic side:

“… prediction-market traders are moving sharply towards a new favorite. Virginia Governor Tim Kaine, who rated only one-in-ten odds a week ago, is now given a one-in-three chance of winning the number two slot … Beyond Mr. Kaine, Mr. Bayh is the second favorite with a one-in-four chance, followed by Ms. Sebelius with a one-in-six chance, and Mr. Biden with a one-in-eight chance.”

Interestingly there is much less trade on the Republican side. Nonetheless:

“… the two clear picks are either Minnesota Governor Tim Pawlenty, or former Massachusetts Governor Mitt Romney.

Each man is rated around a one-in-three chance to win the nomination … traders believe Tom Ridge, the former Secretary of Homeland Security, and Alaska governor Sarah Palin to be the next most likely contenders.”

How seriously should we take these markets? After all, we are trying to guess the decision of an individual politician, rather than the decisions of the entire electorate.

“This can change the role played by the market. This column has often characterized prediction markets as aggregating widely dispersed local information. Instead, the VP markets are likely parsing publicly-available information, and pundits may be equally as adept at this task.

If there is the possibility that political insiders are betting, this further complicates things, as no trader wants to be on the losing end of a bet with a true insider. This anxiety, in turn, makes traders particularly sensitive to any new activity, as the fear of being beaten by an insider can lead informed speculation to be mistaken for inside information. In such an atmosphere, prices can move sharply even when only small amounts are bet.”

I’m willing to give betting advice, informed by a combination of history and behavioral economics:

“It is worth recalling the historical tendency for campaigns to announce surprising vice-presidential candidates, such as George W. Bush choosing the head of his search team, Dick Cheney, as his nominee, or his father’s selection of Dan Quayle. While John Edwards was a fairly predictable Democratic pick in 2004, Joe Lieberman was a surprise in 2000.

Compare this history of surprises with the fact that markets believe that they have narrowed the Democratic and Republican shortlists to four candidates — and, in each case, there is greater than an 80 percent chance that this shortlist contains the eventual nominee. Given the psychological evidence that traders are often overconfident, I think there is good reason to take these quantitative assessments with a grain of salt.”

Even though I think the markets have the candidates in the right order, I would still be shorting the favorites, as it remains likely that someone pulls a rabbit out of a hat.

My full column is available here; for related commentary, see ABC’s Veepbeat.

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  1. Nathan says:

    The difference for me between a pundit and the prediction market is that if pundits are wrong, well no one cares the next day. It doesn’t really hurt them, they just get paid to speculate. In fact they benefit from making the race more interesting so there is really no incentive to tell the truth.

    With the prediction markets, that’s people putting money on the table. They have a real incentive bet on the truth. So I assume they are watching this stuff a lot closer and a lot more critically than even the pundits.

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  2. jimi says:

    McCain should implore Colin Powell.

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  3. Cory says:

    “Given the psychological evidence that traders are often overconfident, I think there is good reason to take these quantitative assessments with a grain of salt.”

    But in this futures market there must be a seller for every buyer. Does the evidence show that the buyers are more overconfident than the sellers?

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  4. frankenduf says:

    Obama-Clinton would win in a landslide; Obama-Edwards handily; Obama-Biden easily; Obama-Kaine?!- sigh, let’s get ready for four more years…

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  5. patsy says:

    to frankenduf @#4

    Which Edwards? Why not Elizabeth?

    ….and I think Obama-Kaine sounds like something you get before root canal….

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  6. Black Political Analysis says:

    What would be interesting is knowing how far off the scuttlebut was in ’88 with Quayle, ’00 with Lieberman and ’00 with Cheney. Where people at least close in thinking Bush (’88) would pick a younger congressperson, or that Gore would go with a Senator, or that Bush was looking for someone with executive branch experience. If pundits are generally close about what type of person the nominee seeks, then these prediction markets might have some value. Otherwise, you might as well throw names in a hat and cross your fingers.

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  7. Gary says:

    Voted best comment of the day:

    ….and I think Obama-Kaine sounds like something you get before root canal….

    — Posted by patsy

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  8. Danny says:

    As an frequent vp speculator on intrade I think much of this column is correct. There are incredibly sharp spikes in prices based on editorials with very little probable real new information. There seems to be some sort of formula emerging that a positive mention in the press is worth a 3-5 point bump while being largely ignored in an article causes a slow decline back to some generally accepted base price.

    So far it seems to me that the optimal time to sell is when someone has just gotten a large spike (see Kaine last week) and the best time to buy is usually when someone is forgotten for the moment but who retains the appeals that had made him or her attractive in the first place (Sebelius a week ago). People seem terrified of missing the one real piece of info that leeks out that they go overboard trying to be first in everytime a new rumor starts. Even if they get one right, it’s likely they will have already lost all that they would have made to the smart traders who aren’t so easily swayed by each editorial.

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