My latest column in the W.S.J. assesses whether Intrade’s political prediction markets have been distorted by market manipulation:
Over recent weeks we’ve observed a pattern of large orders for Sen. McCain on Intrade … executed at times when liquidity is particularly scarce. These orders have caused markets to shift sharply, often against the broader political narrative.
The odd pattern has given market-watchers a hint that something was awry, a point recently emphasized by Nate Silver, the election analyst behind FiveThirtyEight.com. This unusual trend … has not let up.
How do we sort out manipulation from regular trading?
The biggest difference between typical market movements and manipulation is that honest traders will usually try to minimize the impact of their trades on the market price; paying higher prices for an asset only cuts into profits. But a market manipulator, intent on buoying the market’s ratings of their preferred candidate, will work to maximize the impact of their trading on the price.
And indeed, the suspicious behavior on Intrade involves large purchases of Sen. McCain’s stock, executed at times when most traders wouldn’t be active. A flurry of buying at about 8 a.m. on Tuesday drove McCain’s stock from 47 to 51; a follow-up buying spree about 12 hours later drove the price from 48 to 51. The same pattern continued on Wednesday, with an 11 p.m. buy from 43 to 46, and was seemingly repeated with another 11 p.m. buy on Thursday, which pushed McCain’s price from 42 to 47.
Consider some further evidence that these trades are due to manipulation:
These price changes are unusually large and occurred during periods of relative political calm. … Prediction markets assessing the fate of important swing states did not mirror these movements. … Alternative prediction markets, including BetFair, British sports books, or play-money markets, also failed to register similar movement for the Arizona senator.
Trying to look beyond the impacts of this attempted market manipulation, how is the 2008 race shaping up?
On Intrade, Sen. McCain is currently given a 36 percent chance to win compared to Sen. Obama‘s 64 percent, which amounts to a 20 percentage point shift to Sen. Obama in recent days. Some part of this shift toward Sen. Obama may simply reflect the fact that his price had been artificially depressed in previous weeks.
Other markets detect an even larger lead for Sen. Obama. BetFair.com, the British prediction market, shows the Democrat to be a 74 percent favorite to win. The Iowa Electronic Markets suggest a 70 percent chance that Sen. Obama will triumph in the popular vote, with a seven-point edge in his expected vote share.
Even as BetFair and Intrade point to different chances of winning the election, they each suggest a roughly similar set of outcomes in the swing states, most of which currently favor Sen. Obama. Colorado, which is likely to be the pivotal state, is rated a 68 percent chance to go to Sen. Obama on both markets.
This isn’t the first time that traders have attempted to manipulate political prediction markets. Indeed, interesting research by Koleman Strumpf and Paul Rhode has shown that such shenanigans may be the norm, rather than the exception.
They find that manipulation may knock market forecasts off course for short periods, but they are rarely off base for long. And even despite these missteps, prediction markets have amassed a pretty impressive record, out-predicting pollsters and pundits. That is, prediction markets are clearly imperfect, but I remain convinced they are the least imperfect tool we have for tracking the political race.
All of this suggests a note of caution when reading the markets, and hopefully this posting will give you some sense of how to assess whether price changes reflect manipulation. I wouldn’t be surprised to see further mischief.
The full article, written with David Rothschild, my star graduate student, is available here.