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Thursday, March 31, 2005

Betting Markets, Political Polls, and Economic Models

I've been using betting /predictions markets like the Iowa Electornic Markets and Tradesports for years in the classroom to demonstrate how prices reflect information. The last U.S. presidential election, they once again did a better job than the polls of predicting the outcome.

The New Economist discusses an article by Andrew Leigh and Justin Wolfers titled Competing approaches to forecasting elections, that compares the usefulness of polls, economic models, and prediction markets using Australian data. From the paper:

While the evidence for economic voting has historically been weak for Australia, the 2004 election suggests an increasingly important role for these models. The performance of polls was quite uneven, and predictions both across pollsters, and through time, vary too much to be particularly useful. Betting markets provide an interesting contrast, and a slew of data from various betting agencies suggests a more reasonable degree of volatility, and useful forecasting performance both throughout the election cycle and across individual electorates.
N.E concludes with some thoughts on the extent of informed trading in these markets. I've often wondered about that too, since professional politicos have such an information advantage over the average (relatively uninformed) trader. My suspicion is that (to the extent that informed trading occurs trading), the preferred venue would be Tradesports.com rather than on the Iowa Electrnic Markets, since (to my recollection) the volume of trade was much higher on Tradesports. However, I'm primarily a corporate finance guy, so I'd welcome comments from any microstructure folks.

Click here for the whole article.

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