Ten Miles Square


October 18, 2012 9:35 AM Convergence between Polls and Prediction Markets in US Presidential Election

By Joshua Tucker

I’m intrigued by the recent convergence between Nate Silver’s 2012 US Presidential Election forecast (which incorporates most of the publicly available polling data) and the futures contracts being sold on an Obama victory at Intrade. Here’s Nate’s most up to the minute forecast (Obama in blue):

And here’s the current cost of a contract that pays $10 if Obama wins at Intrade:

They are, by all accounts, stunningly close to each other. I imagine that there are four possible states of the world that could be generating these results using two completely different methodological procedures.

First, the true state of the world could be that Obama currently has a 65% chance of winning the election, and both Nate’s approach of aggregating across polls and taking account of economic conditions and vagaries of the campaign AND the ability of traders to correctly price risk in the presidential election could be very effective tools in estimating this true probability.

Second, it is possible that both the polls and the prediction markets are suffering from the same sort of biases and arriving at the same conclusion. For example, the true state of the world might be that Obama has an 80% chance of winning the election, but both Nate’s method and the traders are underestimating the participation in the election of people who no longer have a land-line phone.

Third, it may be the possibility that the same factors (e.g., poll results) are driving both Nate’s results and the decision of the traders regardless of the actual state of the world. Maybe traders are watching the exact same polls as Nate, and therefore coming to the same conclusions.

However, I’d like to suggest a fourth possibility (gleaned from reading the comments on the intrade market), which is that maybe a lot of traders are actually reading Nate’s blog. On the one hand, it seems unlikely that enough people participating in a market are getting their information from the same source. And we know that in markets that a lot of factors come into play besides objective information. However, at the same time people who are betting in these markets are risking their own money, which suggets an incentive to seek out information about the state of the race. And these days, an awful lots of roads on the internet lead back to Nate’s blog.

Why should we care if this is the case? I think there are two potential important implications if this fourth possibility is in play. First, it suggests that prediction markets may be less of an “alternative” guess about the outcome of the presidential elections as compared to polls as they may have been in the pre-538.com days. Second, it might be important to account for this kind of feedback loop in the days after the election when we are trying to assess the prowess of various forecasting methods. In a sense, it reminds me a little bit of when I read papers that cite various expert surveys regarding the policy positions of political parties in different countries as having “additional evidence” because they use multiple expert surveys without realizing that those “different” expert surveys are probably talking to a lot of the same people. If Nate’s blog has achieved the iconic status among election watchers that I suspect it may have, then comparing his predictions to the predictions of futures markest like Intrade may not be bringing as much new information to the table as we think. From a pragmatic standpoint, Nate might want to pause before citing congruence between his model’s predictions and pricing in futures markets as a validation of the model. Ironically, this might be a sign not of the model’s validity, but of the blog’s influence!

The challenge to this interpretation, of course, is that the markets and Nate’s blog have not always converged over the course of the campaign. So a next step might be to think theoretically about the sorts of factors that make traders more likely to be attention to the blog; interpreting the effect of big events like debates seems a useful place to start.

[Cross-posted at The Monkey Cage]

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Joshua Tucker is a Professor of Politics at New York University.