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Spot day

May 19th, 2009
.!.

My introduction to futures markets came in a 1960s TV show called Dobie Gillis, most notable for the ‘beatnik’ character of Maynard G. Krebs, played by Bob Denver, later the eponymous Gilligan of Gilligan’s Island*. In one episode, Dobie’s high school class was assigned to do a fantasy investment exercise, and Dobie along with a cute & smart fellow student chose the egg futures markets. The smart student’s moves always paid off, and Dobie decided to copy them all in real life, building up a huge profit. Finally, the smart student announced she was selling, but Dobie intoxicated with success, decided to keep playing. This went on for a few days of rising prices, but finally when Dobie announced he had held on yet again, the fellow student said, with some horror, “But, Dobie, today is spot day”. The final scene was of the back room of Dobie’s dad’s store, filled to the rafters with the eggs on which Dobie had been forced to take physical delivery.**

Today’s Fin, with a piece by Andrew Leigh*** praising betting markets on events like unemployment rates and so on, brought this episode to mind. It struck me that the case for weak-form market efficiency (the market price incorporates all publicly available information) is much better in a market with a spot date in the near future, as is typical of real betting markets. If you are betting on a race to be run this afternoon at 3, there’s not much point in trying to track movements in the market: you’re better off backing whichever horse is offering the best odds relative to your best estimate of winning probability. More generally, markets with a spot date in the near future ought to be relatively immune to bubbles.

While I’m on the topic, I thought I would repost a piece I wrote before the 2007 elections which, I think, puts a bit of a dent in claims that betting markets really represent the superior wisdom of crowds: in this case, the polls were right long before the pundits and the punters came in last. Of course, one data point doesn’t constitute proof, but supporters of betting markets have made strong claims on the basis of fairly limited data.

Politicians routinely say ‘the only poll that counts is on election day’, particularly when they are behind, though that doesn’t stop them paying very close attention the results. But polls are not the only basis for predicting election outcomes. Economists including Andrew Leigh and Justin Wolfers have made a strong case that betting markets provide a more accurate guide than polls. And opinion pages like this one allow pundits to make their own predictions on the basis of information or insights presumably not available to the average punter or poll respondent.

Most of the time, these indicators all point in the same direction. In 2007, however, polls, pundits and punters have given very different predictions of the likely outcome of the election due later this year. Ever since the election of Kevin Rudd as Opposition leader, the polls have given Labor a commanding lead, stable for some time at 58 per cent of the two-party preferred vote, plus or minus the sampling error of 2 to 3 per cent.

Most pundits and political insiders have until recently dismissed these poll results and predicted a resurgence for the government and John Howard. Over the last weekend, however, there seems to have been a sudden collective shift, with a string of pundits suggesting that the government is on the ropes, and Howard himself dramatically playing the underdog card. The trigger for this change of view seems to have been the absence of the much-predicted ‘budget bounce’ in the polls, though in the past such bounces have been the exception rather than the rule.

By contrast, there has been no real shift in the odds set in betting markets. The Coalition is still virtually even money to win, though, thanks to the house spread, the odds on Labor are slightly shorter.

The slowness of pundits to believe the message coming from the polls reflects the experience of the 2001 and 2004 election campaigns, when Howard came from behind to win. It might be argued that such a small sample is not a good basis from which to draw conclusions. After all, back in 1987, Howard seemed to be in a winning position, but was unable to recover from the ‘Joh for Canberra’ fiasco.

That leaves the markets. The idea that markets can provide better predictions than surveys or expert opinions is an example of the general claim that financial markets give the best available estimate of the value of financial assets such as shares. This claim is called the efficient markets hypothesis.

The efficient markets hypothesis comes in several versions, commonly called ‘weak’, ‘semistrong’ and ‘strong’. The weak form says that investors efficiently use all the information available from observing past share prices. In the current context, this says that the betting market should get the outcome right at least as often as someone who bases their judgement on past election results. The most obvious strategy of the latter kind is one of betting on the incumbent government to win, as has happened in 19 of the 24 federal elections since the current party system emerged with the foundation of the Liberal party in 1944.

The ‘semistrong’ form of the hypothesis states that the market makes the best available use of public information, such as opinion polls and the published judgement of presumably expert commentators. The polls have done a pretty good job of picking the changes of government, and most pundits correctly predicted the outcomes in 1972, 1975, 1983 and 1996. On the other hand, at least some of the time, polls and pundits have predicted changes of government that didn’t happen. The most obvious case is 1993, when John Hewson was also a short-priced favorite in the betting markets as well.

The most controversial, strong form of the efficient hypothesis states that market prices reflect both public and private information. It was this idea that led to proposals, rapidly squashed by public outcry to establish futures markets in terror attacks and other political crises.

Tbe current divergence between the results of polls, and those of betting markets, provides what may be a crucial test. If Labor loses, it would be hard to see the point of continuing to report poll results, except in the period immediately before an election. It would seem better just to watch the betting markets.. On the other hand if Labor wins the victory long predicted by their surveys, the pollsters can celebrate.

In the end, though, there is still only one poll that counts.

* I could, of course, have checked all these details on Wikipedia, but I promise I didn’t.
** A similar story is told of Keynes, whose speculative career, spectacularly successful on the whole, included some big disasters.
*** Paywalled, but Andrew, along with Justin Wolfers has written a lot along these general lines, so Google is your friend.

Categories: Economics - General Tags:
  1. TerjeP (say tay-a)
    May 19th, 2009 at 13:53 | #1

    A bit off topic but I’ve argued for a long time that monetary policy should pay more heed towards working to stabilising commodity spot prices. The reason for this is that spot prices rapidly reveal any errors in monetary settings whilst proxies such as the CPI are subject to all kinds of long lags and delayed update. Fast feedback has a virtue in system stability.

  2. Uncle Milton
    May 19th, 2009 at 15:47 | #2

    Legend has it that Keynes, who liked to dabble in the futures markets, forgot to close out a wheat futures contract and was forced to take delivery, which he stored in the chapel of King’s College, Cambridge.

    Small pedantic point: the TV show in question was called, I think, The Many Loves of Dobie Gillis.

  3. Alphonse
    May 19th, 2009 at 15:57 | #3

    Her name was Zelda Gilroy and she was scary smart.

  4. paul walter
    May 19th, 2009 at 16:04 | #4

    Am sure ethnologists will have a field day with this thread. Sort of has one in mind of twenty thousand years ago; the fur-skin draped ice-age cave men crouching around a spit-painted image of a bison, chanting for success for the forthcoming hunt.
    Or maybe a seance in the nineteenth century- mounting anticipation at the imminent arrival of the ectoplasm, or the Roman augeries “reading” chicken guts.

  5. Alice
    May 19th, 2009 at 16:06 | #5

    Oh my goodness – I must be very old. I just remembered Zelda Gilroy thanks to Alphonse! Didnt she have big thick black glasses?

  6. Monkey’s Uncle
    May 19th, 2009 at 18:24 | #6

    I don’t believe the 2007 federal election results really disprove the efficient markets hypothesis.

    Consider. Throughout 2007 the opinion polls consistently had Labor on between 55 and 61% of the 2PP vote all. On election day Labor polled under 53% of the 2PP vote. So the average opinion poll result for the year was consistently overestimating Labor support above and beyond the standard error margin.

    Of course, the standard explanation is that there was a late swing back to the Howard government. But this doesn’t make any sense, considering that the end of the campaign was disastrous for the Coalition (with the Lindsay fraudulent flyers fiasco and so forth).

    I think that the opinion polls actually shifted more support to Labor in the election, because they created something of a bandwagon effect for Labor and gave the Labor Opposition credibility with the electorate during times of pressure.

    So what really happened is this. The betting markets earlier in the year were picking up the fact that the polls were exaggerating Labor support. But as the year progressed, Labor managed to convince enough voters and the betting markets gradually factored this in and shifted in Labor’s favour.

  7. May 19th, 2009 at 20:33 | #7

    Monkeys Uncle – you are essentially suggesting that lots of people vote as if they were having a bet. In other words they vote for who they think will win rather than for who ought to win. Perhaps they believe so strongly in democracy that they think that the most popular candidate ought to win and so they vote accordingly. Baa.

  8. rog
    May 19th, 2009 at 22:25 | #8

    Another example where polls ? betting markets can be seen by recent Bligh win in banana land. In fact betting markets would be broke if popular opinion won the day.

    Talk is cheap

  9. rog
    May 19th, 2009 at 22:26 | #9

    ? = (does not equal)

  10. derrida derider
    May 20th, 2009 at 11:20 | #10

    To elaborate rog’s last point, the real difference between polls and betting markets is that people answering a pollster’s questions (or indeed voting) have no skin in the game – their opinion costs them nothing.

    Not so for punters putting their money where there mouth is. They have a motive to incur the search costs of finding out facts and then making the painful effort of separating their head from their heart.

  11. Alphonse
    May 20th, 2009 at 16:55 | #11

    I don’t remember glasses, Alice. What I do remember is a cutesy wrinkly squinty kind of thing she did with her nose. Dobie invariably couldn’t help doing it right back at her before recovering himself and yelling “now cut that out, Zelda!”.

    Obviously, you were way to young to absorb the detail.

  12. Roo
    May 20th, 2009 at 19:50 | #12

    Alice,I remember Zelda’s glasses. Also, exposure to Rodin’s sculpture, The Thinker.

  13. jquiggin
    May 20th, 2009 at 20:47 | #13

    I’m with those who recall the glasses.

  14. SJ
    May 20th, 2009 at 21:14 | #14

    Hey, are you guys aware that there’s this thing called Google Images?

    No glasses.

    The character Velma in Scooby-Doo was based on Zelda. Velma had the glasses, not Zelda.

  15. SJ
    May 20th, 2009 at 21:16 | #15

    Cite for the Velma/Zelda relationship.

  16. David Peetz
    May 20th, 2009 at 21:27 | #16

    An even clarer indication of the weakness of the efficient market hypothesis when it comes to predicting election results was in the betting for the seat of Bennelong.

    Every opinion poll taken in that seat through 2007 had Howard losing.

    Yet right through the year, the betting markets had Howard winning, even up until the begining of the last week of the campaign.

    We now know that by the time of APEC, a couple of months before the election, even Howard recognised the message of the polls – that he was going to lose his seat. Yet the betting markets stubbornly suported him.

    This was not a thin market – it was a high profile seat for obvious reasons and so I suspect the one with the heaviest trade.

  17. jquiggin
    May 20th, 2009 at 21:36 | #17

    SJ, no fair looking up actual sources :-)

  18. Alice
    May 20th, 2009 at 21:38 | #18

    14# SJ – I realised that. I checked google images on Zelda. No glasses – you are quite correct (which makes my memory faulty – but hey it was decades ago!). A horrible short fringe and pony tail but no glasses. So Velma? Ill check!

  19. Alice
    May 20th, 2009 at 21:47 | #19

    Oh Ive got it…Zelda (without glasses) was the inspiration for Velma Dinkley (with glasses) of Scooby Doo fame!

  20. Alice
    May 20th, 2009 at 21:51 | #20

    Hey guys we are all wrong and SJ is right! No glasses on Zelda! (on Velma who came later…different show…Scooby Doo… based on Zelda…oh how the memory can play tricks!)

    I swear I saw black thick glasses on Zelda though…

  21. Alice
    May 20th, 2009 at 21:57 | #21

    Im still not 100% convinced …maybe Zelda had thick black glasses in an earlier episode … you know how women get more attractive in movies later…etc (glasses ditched?)

  22. Jim Birch
    May 21st, 2009 at 10:12 | #22

    Black (rimmed) glasses glasses are a conventional indicator for a smart but unsexy girl/woman in US popular culture. They go together in our minds, – kinda like privatised and efficient, I guess – irrespective of their case-by-case veracity.

  23. David Irving (no relation)
    May 21st, 2009 at 14:10 | #23

    I can’t remember one way or the other about the glasses, although I watched the show religously.

  24. nanks
    May 21st, 2009 at 14:20 | #24

    I watched the show and remembered Zelda without glasses

  25. Alice
    May 21st, 2009 at 19:18 | #25

    Maybe Im mistaking Zelda for Brian Henderson?…

  26. nanks
    May 21st, 2009 at 19:21 | #26

    “Maybe Im mistaking Zelda for Brian Henderson?…”

    lol

  27. Alice
    May 21st, 2009 at 19:22 | #27

    It appears thick black glasses may be coming back into fashion. Cate Blanchett was recently spotted in a pair.

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