Biden is currently winning “prediction” markets
By: Mike Co
Tags: Money, Elections, Economics, Economy, Politics

Biden is currently winning “prediction” markets

How accurate is the term anyways?

Source: QuiverQuant from PredictIt

Democrats have taken a significant lead in the PredictIt prediction market for the first time. Biden is currently priced to win the 2020 election with ~59% probability. The Democrats’ odds shifted at the beginning of June, catalyzed bya resurgence of coronavirus cases in the U.S. Conventional polling averages from FiveThirtyEight also affirm a Biden lead since March.

Which is a more reliable forecast: prediction markets or conventional polls? In 2016, faith in traditional polling was shaken as the historically accurate FiveThirtyEight failed. Only a year prior, a considerable alternative poll emerged: PredictIt. Also known as a prediction market, others may know it by a less prophetic term: a betting market. Put simply, participants can bet their hard-earned money on the potential outcome of a political event occurring.

As opposed to sports, there is a real academic purpose to political gambling. Sponsored by researchers from a myriad of prestigious academia, the question is whether or not there is truly wisdom in the crowd: Thousands of participants stake their money on the perceived likelihood of a wide variety of political outcomes (and even for betting on average global temperature). With money at stake, a gambler is theoretically incentivized to make the most informed guess possible.

As thousands of participants buy and sell contracts according to the size of their conviction, the market would effectively indicate the most educated likelihood possible. Intuitively, would you rather trust the TV talking head for political forecasts, or a thousand people putting their money where their mouth is? Markets never lie, as opposed to pundits.

In the early 2000's, the U.S. Defense Advanced Research Projects Agency (DARPA) developed a prediction market based on its potential for “proactive analysis.” According to research by NBER: “Prediction markets prices typically provide useful (albeit sometimes biased) estimates of average beliefs about the probability an event occurs.” Despite its potential however, U.S. senators found the idea of betting on the likelihood of terrorist attacks to be too grisly to allow.

There is certainly wisdom in efficiently aggregating the opinions of many participants while also incentivizing education. On the other hand, the forecasts of the crowd can sometimes be very wrong. In 2016, PredictIt performed as poorly as conventional polls in predicting the true likelihood of a Trump victory.

The fact is, even within highly liquid financial markets, the wisdom of the crowd can fail miserably at pricing event probability. At the same time, there should always be an incentive to root out the truth with a disproportionate payoff. Just ask Michael Burry from The Big Short. Or in the words of an employee from a popular sports betting market:

“Polls are one thing. But when people bet, where the money goes is often very revealing. People who are prepared to bet fairly large sums, and who wouldn’t normally bet, often have very good reasons for doing so.”

For now however, political markets are still a fairly limited academic experiment. There is high friction to enter PredictIt markets (5% fees) and there is a maximum bet of 850$, inherently limiting the “efficiency” of the market. If prediction markets ever increased in size however, it would likely increase the scrutiny (similar to the DARPA prototype) and incentive for manipulation.

In 2004, an Irish sports betting market called Tradesports had a remarkable record at predicting events. As media like the Wall Street Journal began to seriously consider the market’s probability, a single individual attempted a “bear raid” it to sell Bush’s market probability to near-zero. Despite such manipulation, Robin Hanson, a researcher at George Mason University has claimed that market “manipulators are unable to distort price accuracy.” As the price strays from reality, the monetary incentive for balance becomes stronger.

Prediction markets are powerful and fascinating tools. At the same time, they are an aspect of the never-ending and elusive Efficient Markets debate. Will Trump win again despite the wisdom of the crowd? Or has the crowd gotten smarter this time?

Only in November will we know for certain.