Predicting election results

First the pollsters let us down and now it’s the online prediction market, where you buy or sell a contract tied to the outcome of an event — as in Will Barack Obama win the nomination? Intrade, a market maker based in Dublin, is the leading site for such betting, and it's proven to be eerily reliable over the years. In 2004, President Bush won every state in which Intrade’s contracts the night before the election gave him a better than 50 percent chance of winning. He lost every state where the traders thought Kerry was the favorite. Thing is, Intrade messed up big-time in the recent California primary, with prices on Tuesday night suggesting that Obama would beat Clinton. So what happened? The NYT's David Leonhardt discovered that the collective wisdom of the masses, which is the central premise behind trading futures, doesn't always apply when handicapping politics.

Intrade is different because there still isn’t all that much trading on the site. (For legal reasons, Americans often have to use bank transfers, instead of credit cards, on the site.) John Delaney, Intrade’s chief executive, said that roughly $50 million in contracts tied to the 2008 election had changed hands already, which is up from $15 million for the entire 2004 election cycle. But $50 million is still roughly equal to the value of ExxonMobil shares that change hands every 10 minutes. The limited size of Intrade’s market has created two main problems. The first is that the biases of a small group of traders can have a big effect on prices. And these biases seem most obvious in exaggerated odds for unlikely events. As Justin Wolfers, a University of Pennsylvania economist who studies prediction markets, notes, the odds “hit 5 or 10 all the time when a guy is dead in the water.”

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The second problem is that the market seems to react to new information too slowly. In a healthier market, you can’t easily predict where prices are going. After the drug maker Schering-Plough reported strong earnings on Tuesday, for example, its stock price jumped. But the stock is unlikely to continue soaring in coming weeks. The market has already adjusted to the news. On Intrade, such reactions often happen in slow motion — and eventually turn into overreactions. Mr. Obama’s stock rose for days after he won Iowa, then fell during the two weeks after he lost New Hampshire and rose again in the 10 days after he won South Carolina. The impact of each contest took surprisingly long to sink in.

For what it’s worth, Intrade shows Obama getting the nomination (at last check he was given a 75 percent chance). McCain had a 95 percent chance. The WSJ also looks at the prediction traders.