A really convincing case study often has more power than a mound of statistical analysis and, for me at least, observation of the just-completed election campaign has convinced me of the correct analysis of the predictive power of betting markets, relative to polls and pundits.
To recap, the polls (which had previously put Labor just in front) showed a big shift to Labor as soon as Kevin Rudd became Labor and stayed virtually unchanged for the subsequent year, narrowing by a percentage point or two after the campaign was called. This graph from Possum’s Pollytics tells the story.
At first no-one (neither punters in betting markets, nor political pundits, nor the public in their predictions) believed the polls. But over time, they all came around, until by election day, it didn’t matter whose predictions you used, you would have been pretty much right.
Given that the polls often bounce about, it was reasonable enough not to predict a Labor victory in the immediate aftermath of the Rudd bounce. On the other hand, if the punters, taken collectively, had some special insights not accessible to pollsters, they failed to show it.
To my mind, this supports what is called the ‘semi-strong market efficiency’ hypothesis. That is, given all available information, including the polls and the analysis of pundits, the market prediction is likely to be about as good as you can get. But Kevin 07 pretty convincingly refutes strong forms of the efficient markets hypothesis such as those that were used to promote markets in ‘terrorism futures’ and similar stuff. Moreover, I think it’s safe to say that without the polls no-one would have seen this coming.
So, given that polls exist, markets do a pretty good job of taking them into account. But if we didn’t have polls, markets would be way off-beam a lot of the time.
Interestingly, the patterns of the year repeated in microcosm on the night. The Sky exit poll was virtually spot-on, and both the markets and the pundits called the result, almost simultaneously, a few hours later.