In the weekend edition of the Fin (reproduced here), Justin Wolfers writes about a betting market on the Iraqi election turnout, run by the Irish betting exchange Tradesports. The bet turned on whether turnout would exceed 8 million and was roughly even money before voting began. The price of the contract rose sharply on early reports of turnouts over 70 per cent, then fell back again when to around even money when it became clear these reports had little basis. The final official turnout was about 8.4 million.
Attentive readers will recall that something very similar happened in the US election when early exit polls favored Kerry. Modifying an old aphorism to say that “two striking observations constitute a stylised fact”, I think we can now say pretty safely that political betting markets display the wisdom of crowds who read blogs.
In economic terms, we need to look at the implications for the efficient markets hypothesis, which comes in various levels of strength. The weak form, that you can’t predicted prices on the basis of their own past movements is well confirmed, and not of much interest here. The semi-strong form is that markets make the best possible estimate, given available public information. This, I think, is still open for debate. Obviously markets react to the news, but in these two instances they appear to have over-reacted. So, it seems likely that in a market with new information arriving continuously, we would replicate the stockmarket finding of excess volatility.
Finally, there’s the strong form of the hypothesis which is that markets make the best use of all available information, public or private. This has clearly failed, or else been shown to be irrelevant. Either there was no information anywhere to suggest that the early reports were wrong in these cases, or there is or there was no useful private information which markets failed to incorporate in prices.
Now, let’s look back at the most controversial proposal for use of betting markets, the idea of ‘terrorism futures’. Since most of the interesting information here is private (the public gets color-coded alerts and that’s about it), the claim that a market in terrorism futures would provide useful information depends on the strong form of the efficient markets hypothesis. The (stylised) fact is that strong form efficiency doesn’t hold in political markets, and therefore that terrorism futures would provide no useful information.
On the success side for betting markets, they got it right in predicting that Labor would win in WA, but then, so did everyone else.
fn1. In a strict sense, the private information obviously existed. People knew whether and how they had voted, and a perfectly aggregating information market should have been perfectly informed about the votes that had been cast, and well-informed about votes that people intended to cast.