Number 44

By watching the political stock market it is possible to gauge the effect of an ad, a policy announcement or an alleged affair on the part of a candidate almost instantaneously

On this the eve of what has been the most interesting Presidential campaign in modern times, Honestly Lay Bare revisists a concept that we touched upon in February 2006 about prediction markets.

See: http://www.honestlylaybare.com/2006/02/internal-internet-based-virtual-stock.html

The purpose of today is not to rehash the relevancy of such markets to the management of risk within corporations nor is it to push any one political viewpoint.

No, the purpose of today is to put one such market - the Iowa Electronic Market - to the ultimate test (and to pander to Honestly Lay Bare's near insatiable appetite for American politics).

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The Iowa Electronic Markets, or IEM, is a group of real-money preidction markets / future markets operated by the University of Iowa Tippie College of Business.

The IEM allows traders to buy and sell contracts based on, among other things, political election results and economic indicators.

The premise behind the IEM, which was first used in the 1988 presidential election, is that voters don't have any incentive to tell pollsters the truth.

But when their own money is on the line, people will act on information that affects the chances the candidates have of winning or losing an election.

The political election results have been highly accurate, especially when compared with traditional polling.

This may be because it uses a free market model to predict an outcome, instead of the aggregation of many individuals' opinions. The speculator is more interested in a correct outcome than in his or her desired outcome.

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In the final days of the 2008 campaign (as of Friday 31st October 2008), traders on the IEM continued to favor Barack Obama and Congressional Democrats to win next week's general elections.

A contract for Obama was selling for 85 cents on the IEM's Winner Take All market, while a contract for John McCain was selling for 15.3 cents.

The numbers mean that IEM traders believe there is an 85 percent probability that Obama will win the popular vote on Tuesday, while McCain has a 15.3 percent probability of winning.

The 85-15 price spread has been largely unchanged for about three weeks.

On the IEM's presidential Vote Share market, Obama's contract was selling at 54.7 cents, while McCain's was selling at 47 cents.

Those figures mean that traders believe Obama will receive 54.7 percent of the two-party popular vote, while McCain will receive 47 percent.

On the IEM's Congressional Control markets, Democrats are being given a 96.1 percent chance of maintaining control of both chambers of Congress. House Democrats have a 98.8 percent probability of adding to their majority and Senate Democrats a 97.5 percent probability of adding to theirs.

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Come Tuesday - assuming no hanging chads - we will find out whether the IEM is right.

If it is, score that as another win for predictive markets.