Jim Bourg / Reuters file
The GOP presidential field includes, from left, former U.S. Sen. Rick Santorum, U.S. Rep. Ron Paul, Texas Gov. Rick Perry and former Massachusetts Gov. Mitt Romney, shown at attention during the playing of the National Anthem during a Nov. 22 debate. Romney, Paul and Santorum are favored to finish in the top three spots in the Iowa GOP caucuses, while Perry's fortunes have fallen in the polls and the prediction markets.
By Alan Boyle
Last updated 11:25 p.m. ET:
The pundits are?portraying tonight's Iowa GOP presidential caucuses as a tight three-way race, but market traders settled on an order of finish even before the voting began: Former Massachusetts Gov. Mitt Romney first, U.S. Rep. Ron Paul second, and former U.S. Sen. Rick Santorum third.
When it comes to the Republican nomination, Romney has?a commanding lead ... at least for now.
Iowa's precinct-level party caucuses are convened to select delegates to go to the county-level conventions, but the real?reason why?GOP presidential candidates have been spending the past few months shuttling around the Hawkeye?State is because this is the first real-world test of strength?in an actual 2012 election. The same could be said?for the pollsters and the prediction markets.
Most of the political handicapping you've heard about so far is based on traditional polling, which tallies up voters' preferences as expressed during telephone interviews. But for more than two decades, researchers have been experimenting with market techniques for sizing up political propositions ? and so far, they've found that open market exchanges have been at least as accurate as the pollsters in predicting the results of elections.
Justin Wolfers, an economist at Penn's Wharton School who's been studying prediction markets for years, expects the accuracy record to hold for tonight's results, even though caucus outcomes are notoriously difficult to predict.
"All the usual ways we have for gathering information, including polls, are going to be much more screwy," he told me today. "Someone's going to be surprised tomorrow. But ...?empirical evidence suggests that prediction markets will be the least bad predictor."
How political markets work
Prediction markets let investors purchase "shares" in a particular proposition ? for example, that Romney will finish either first or second in the Iowa caucus vote. Over the course of the campaign, they can sell off those shares and buy different ones, depending on how they gauge the candidates' chances. The price fluctuates based on supply and demand, but when the election occurs, the traders who backed the winning proposition get a set payoff. The traders who backed the wrong horse get nothing.
The idea is that markets?provide a good vehicle for distilling?the "wisdom of crowds," particularly when traders put their money or prestige behind their prediction. It's a lot like online gambling, but totally legal.
The nation's longest-running political prediction market happens to be headquartered in the Hawkeye State: Traders on the Iowa Electronic Markets buy and sell?shares with real money, in hopes of reaping a $1-per-share return. Their?account is limited to $500, so nobody makes a fortune. But the exercise is a valuable research tool for economists at the University of Iowa's Tippie?College of Business, which manages the markets with the permission of federal regulators.
Inkling Markets offers similar political trading, but with play money rather than real money at stake. And then there are offshore betting markets such as InTrade and Betfair. A website known as PredictWise.com aggregates the InTrade and Betfair statistics for political propositions.
On all these markets, the stated percentage or value for a given proposition reflects the probability that the proposition will come true. That's different from political polls, which reflect voter preferences in percentage terms. Thus, the numbers you see on the political markets don't exactly track the numbers you see in polling results. But the rankings are the same: Romney first, followed by Paul and Santorum. Here's how the markets looked at?4:45 p.m. this afternoon, with 100 being the maximum value:
? Iowa Electronic Markets: 81.8 cents for Romney, 69.6 cents for Paul, 51.8 cents for "Rest of Field" (primarily Santorum). This is a market to predict who'll be in the top two.
? Inkling Markets: 73.2 percent for Romney, 15.3 for "Anyone Else" (primarily Paul), 10.1 for Santorum.
? Betfair: 48.3 percent for Romney, 29.4 for Paul, 23.1 for Santorum.
? InTrade:?49.3 percent for Romney, 25.6 for Paul, 24.2 for Santorum.
IEM
This chart shows the wildly fluctuating values for candidates' shares on the Iowa Electronic Markets. For the past few days, Mitt Romney's shares have been most highly valued, followed by Ron Paul and ROF or "Rest of Field," which includes Rick Santorum.
The projected outcome, as reflected in the markets, closely tracks what the polls are suggesting today, Wolfers said. "The prediction markets are somewhat more bullish about Mitt Romney," he observed. If Romney doesn't lead the pack tonight, that would be a huge surprise for the pundits ? and for the traders as well. If Romney finishes behind Paul and Santorum, someone who put their money on the "Rest of Field" (such as?Santorum) to finish in the top two would come close to doubling their investment in a day.
There are a few additional twists to the trading. For example, much has been made of Santorum's late surge in the polls, but the trading?suggests that the?surge hit its peak a few days ago and has since fallen back.
After the top three, the GOP field's share values drop dramatically. University of Iowa spokesman Tom Snee noted that within the past few days, traders had U.S. Rep. Michele Bachmann's shares at 0.2 cents, compared with businessman Herman Cain's 0.3 cents. "What?they're saying is that Bachmann has less of a chance to win than someone who's not running anymore," Snee said. (Cain's shares have sunk since then, however.)
The big picture for the GOP nomination
As of today, the traders on all the markets?give Romney?the overwhelming?edge for the Republican nomination. The IEM has him at 81 cents, Inkling?has him?at 85.06 percent, and Betfair and InTrade?have him at 74.4 and 79.8 percent, respectively.
If Romney falters in Iowa, these prices could change overnight. Literally.
Joyce Berg, the IEM's director, noted that?four years ago, Hillary Clinton was the market favorite before the Iowa caucuses, but was displaced by Barack Obama afterward. Clinton made an unexpected resurgence in the 2008 New Hampshire primary but eventually lost ground again to Obama. "What we're seeing is that markets are very good aggregators of news," Berg said. "In our markets, people appear to trade with their heads, not their hearts."
The IEM's traders?are primed to respond quickly to the results of the caucuses, just as traders on the New York Stock Exchange respond quickly to the latest unemployment figures. So the fact that Romney?has been on top for the past few months is no guarantee, in the political world or in the marketplace. "If he did not finish in the top two, that would be news," Berg said. "You would expect that to show up in the Republican convention market."
Wolfers said the fact that the GOP field has been so wide in the run-up to the Iowa caucuses has made this "one of the most unstable markets we've ever seen," in large part because the different voting constituencies don't want to waste their votes on someone who's not perceived as a potential winner. Evangelical Christians, for example, might waver between several candidates based on the perception of their chances.
"It's not a standard two-horse race," Wolfers observed. "The dynamics when you have strategic voting are very, very volatile."
Will tonight's results confirm the verdicts of the polls and the markets? Or will?fortunes be won and lost?by Wednesday morning? Weigh in with your comments below, and check back later tonight for the bottom line.
Update for 5:45 p.m. ET: Mashable and Global Point Research are checking out whether positive sentiments expressed in Twitter tweets can be correlated with the Iowa caucus results. Analysis of data collected between Dec. 27 and 30 shows a big spike for Santorum, which would mesh with his surge of support in the polls and prediction markets.
Update for 9:28 p.m. ET: The betting on InTrade and Betfair has shifted quickly?toward Ron Paul. He's now the favorite to win. Romney has fallen to No. 2, with Santorum rated No. 3. The order on the IEM and Inkling Markets is unchanged: Romney, Paul, Santorum. Because traders on the IEM are investing in a top-two finish, the payout is?the same?if it's a Romney-Paul or a Paul-Romney finish. Inkling, meanwhile, closed its market for the night at 9 p.m. ET, so there'll be no chance for folks to change their prediction.
Update for 11:25 p.m. ET: Now it's clear that Ron Paul will finish third, but Romney and Santorum are neck-and-neck for first and second. InTrade and Betfair?currently favor Romney to squeak out a victory. The IEM's traders are basically valuing Romney's and Santorum's shares at the maximum price of $1, in recognition of the fact that they're both in the top two. It was possible to make a quick buck by betting on Santorum today: Someone who invested $51.80 in 100 of his shares this afternoon will get $100 on Wednesday.
More about prediction markets:
For the latest results from Iowa and their significance for the 2012 presidential campaign, check in with NBCPolitics.com.
Alan Boyle is msnbc.com's science editor. Connect with the Cosmic Log community by "liking" the log's Facebook page, following @b0yle on Twitter and adding the Cosmic Log page to your Google+ presence. You can also check out "The Case for Pluto," my book about the controversial dwarf planet and the search for new worlds.
Source: http://cosmiclog.msnbc.msn.com/_news/2012/01/03/9923436-political-markets-get-first-2012-test
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