DavidMRothschild on June 08, 2011 @ 3:50PM
This morning Nate Silver, writing in his blog in the New York Times, notes the disconnect between a few recent polls and Intrade's prediction market in regard to the likelihood of Mr. Huntsman ultimately gaining the Republican nomination for President. He is concerned that Republicans are giving Mr. Huntsman the highest "unacceptability" ratings of any major Republican vying for the 2012 Presidential nomination; 51% of Republicans state that he is unacceptable in recent polls. Yet, despite these unacceptability ratings, Mr. Huntsman is being given 13.3% likelihood of the Republican nomination by the prediction markets, placing him in a strong third place (the fourth place contender, Ms. Palin, is at just 6.7%).
As Mr. Silver notes, Mr. Huntsman is unknown to most Republicans and, if they know anything, they are likely to only know that he was an ambassador for President Obama. I will quote the comment on the New York Times article written by "David from NJ" (who, despite the description, is not me!): "The press on Huntsman has characterized him as a moderate and his role as ambassador to China puts him in the Obama camp. The net is he falls in the same group as Romney and Pawlenty, with possibly less well known knowledge about his positions than either."
The first reason that prediction markets (Intrade and Betfair are very close on these numbers) differ from the polls is that prediction markets take into consideration what the Republican voters will learn between now and their primary elections, while polls do not. Knowledgeable prediction market users are expecting voters to eventually learn what "David from NJ"already knows: that Mr. Huntsman is not in the Obama camp, but a standard Republican. The prediction markets are predicting that those unacceptability numbers will disappear in the next few months.
The second reason that prediction markets differ from the polls is that the prediction market users assume that Mr. Huntsman, in expectation, matches up the best against Mr. Obama in a general election. Mr. Obama has a 62.7% likelihood of winning the general election, but that number is related strongly to the likelihood of meeting his different potential Republican challengers. He is more likely to beat some challengers than others.
Mr. Romney has a 30.0% likelihood of winning the nomination and an 11.7% likelihood of winning the general election. When thinking about "electability" what I think about is the likelihood of winning the general election assuming the candidate wins the nomination. For Mr. Romney, that likelihood is 39.0% or 11.7/30.0; Mr. Romney‘s electability is similar to Mr. Pawlenty (33.5%) and Ms. Palin (37.9%). All three of these fall in the middle range, making them about as likely to win a general election as the average Republican challenger against Mr. Obama. Ms. Bachman, who is a very extreme candidate, has an electability of just 27.6%. If she won the nomination, Mr. Obama's likelihood of wining the general election would shoot up to nearly 75%.
Mr. Huntsman has a 48.5% likelihood of winning the Presidential election,contingent on winning the Republican nomination. Thus, the second reason that the prediction markets think Mr. Huntsman is so likely to win the Republican nomination, despite his initial weak polling numbers, is that he is the most viable candidate for the Republicans in the general election. He is the only candidate that the markets think could turn the general election into a dogfight.
2012 President - Likelihood of Republican Nomination
DavidMRothschild on June 07, 2011 @ 6:59PM
As of today, the championship series in both basketball and hockey stand at 2 games to 1 game. PredictWise has determined that the Heat (up 2-1) are 75.9% likely to win the NBA championship and the Canucks (up 2-1) are 74.6% likely to win the Stanley Cup. For the sake of this article, I will say both currently leading teams are about 75% likely to win their respective titles.
There are ten possible scenarios of wins (W) and losses (L) that can occur when a team has a 2-1 advantage in a best of seven series. In six scenarios they win the title (WW, WLW, WLLW, LWW, LWLW, LLWW) and in four scenarios they lose the title (WLLL, LWLL, LLWL, LLL). The probability that they win the title is sum of the probabilities of the first six scenarios. If I assume that any given game is 50% for both teams (i.e., the teams are both equally likely to win any given game), the first six scenarios add up to 68.8% probability that the leading team will ultimately win the title. Thus, the market (and consequently PredictWise) does not believe that each game is independent and does not believe that both teams have a 50% likelihood of winning any game.
The market may be assuming that the leading team has a greater than 50% chance of winning any future game. If that is the case, to give the leading team a 75% probability of victory, the market needs to assume that they have 55% likelihood of winning any given game.
The market may be assuming that there is a home arena advantage, where both series have two games left at each team's home arena. If that is the case, to give the leading team a 75% probability of victory, the market needs to assume that the home team has a 75% probability of winning any given game. The leading team just needs to win its two home games, while the team that is down 2-1 needs to win at least one game on the road.
The final thing to consider is whether or not streaks affect a team's chances of winning. If the leading team wins game 4, on the road, and takes a 3-1 lead, does that make them even more likely to win game 5? If the team that is down 2-1 wins the next two games to take a 3-2 lead, does the other team become demoralized?
Enough with the theory, both leading teams are on the road for game 4. The Mavericks and Bruins, both down 2-1, are approximately 55% favorites to win the game in their home arena. Thus, there is clearly a home advantage, but not to the extreme necessary to cover the 75% probability of the leading team winning the title. Thus, there must be some element of a greater likelihood of victory being assigned to the teams currently in the lead and a non-independence of the different games, where if they win game 4, they increase the likelihood of winning game 5 against a demoralized opponent. In short,the answer is somewhere between these three simplified explanations.
DavidMRothschild on May 26, 2011 @ 5:42PM
To illustrate the favorite-longshot bias, assume that, six months before an election, an investor believes the Democratic candidate has a 95% chance of winning. There are several reasons why this investor would not pay a full $0.95 for a contract that pays off $1 if the Democratic candidate wins. First, there is an opportunity cost of the bet being held for upwards of 6 months, because there is limited liquidity in many markets. The investor's money is tied up in this market, when it could be out doing something else: sitting in a bank, providing capital for a startup, being used to consume something, etc. The cost is literally the opportunity to be doing other things with the money while it held up in the market. Secondly, there are transaction costs of around $0.015 per $1 invested, thus the investor will actually bid up to whatever she determines is the optimal price minus the transaction cost that will be lost when the bet is processed. Finally, if there are two bets that are equal in expectation, the investor gains more utility from betting on a longshot. It is not clear to researchers whether investors are risk loving (i.e., they gain utility from doing risky things) or beset by misconceptions or Prospect Theory (i.e., they overvalue small probabilities and undervalue high probabilities), but it is accepted in the academic literature that they are not risk neutral.
All this brings me to the subject of Intrade's market for the Democratic Nominee for President of the United States in 2012. Currently, Mr. Obama is trading at a bid of $0.910 per $1 and an offer of $0.937 per $1 for a price of $0.924 per $1. If this seems too low to you, let's examine why you might be correct.
(I should note that the rules of the market specifically state that the contract is voided if any nominee in the market passes away, so that is not an issue.) Let us consider our three remaining causes of the favorite-longshot bias:
First, the market will not settle until September of 2012 (i.e.,15 to 16 months from now). This means that any money tied up in this market is lost for a consider amount of time. Thus, there is a large liquidity cost.
Second, Intrade has just switched to a flat fee model, while there are still transaction costs, they are much lower for Intrade than for any other market, so this is not a big factor in the low price.
Third, people get more utility out of holding (and dreaming about) the longshot Mrs. Clinton to be the nominee, with a bid at $0.030 and an ask at $0.040 per $1, than the favorite Mr. Obama, so they are willing to bid more than is realistically likely in order to own the contract. Again, I am not sure if it is the utility of dreaming about/holding onto longshots, or is it because people are miscalculating long odds. Yet, if an investor deemed an investment in Obama and Clinton equal in their likely payout, they are going to gain more utility from the Clinton investment.
While the direct translation of these prices would say that Mr. Obama has 92.4% likelihood of the nomination and Mrs. Clinton a 3.5% likelihood of the nomination, my calculations would place it closer to 99% and 0.2%. Which one seems more realistic to you?
2012 President - Likelihood of Democratic Nomination
DavidMRothschild on May 18, 2011 @ 1:20PM
Within the past week, both Mike Huckabee and Donald Trump announced that they would not seek the Presidency in 2012. The prediction markets had plenty to say about these candidates both before and after they dropped out of the running. Both men's likelihood of winning the Republican nomination peaked at nearly 9%, but the markets show that the end of their campaigns came about under very different circumstances. Below is a chart of Mike Huckabee's likelihood of winning the Republican nomination, where the red line marks the moment when he made the announcement he was not running during his weekly Fox News TV show. One day before his on-air announcement, when rumors of an impending announcement on his campaign began to spread, this market tanked rather quickly. The market was reasonably quick to recognize that he was going to drop out of the race. However, it appears as though the market began to second-guess itself over the following 24 hours - perhaps due to conflicting rumors - and by the time of his announcement, the Huckabee contract regained about 1/3 of the value lost during the previous day.
Donald Trump's likelihood of winning the Republican nomination peaked just before President Obama released his long-form birth certificate on April 27, and began its precipitous decline just as Obama announced the death of Osama Bin Laden on May 1. The final drop on May 17 coincided with his announcement that he will renew his job as a television personality, rather than run for President. While Huckabee was an extremely viable candidate prior to his announcement, Trump had already been trending towards irrelevancy, even before his announcement.
I regret that we had not been tracking Jon Huntsman's chances until very recently, but the other two candidates who clearly benefited the most probability of victory with the Huckabee announcement were Mitt Romney and Tim Pawlenty. As I note in the first chart there are really two separate noteworthy events in Huckabee's withdrawal from the race. The first occured when rumors of an impending announcement were circulating and the second occurred a day later when his decision was announced. The first reaction of the market was to assume that Romney was going to really benefit from Huckabee's departure. After the rumors began, going into the formal announcement (where the red line is located), Romney had absorbed almost all of the Huckabee's total loss. Yet Romney gained little from the formal announcement while Pawlenty, who had already fallen back down to his pre-rumor level, got a nice boost from the actual announcement. One thing is clear from this analysis: the market is undecided on who benefited from the Huckabee announcement.
DavidMRothschild on May 08, 2011 @ 1:43PM
A key question in political circles over the last few days has been the effect of the death of Osama Bin Laden by the U.S. armed forces on the outcomes of the 2012 election. Indubitably, the event is beneficial to the Democratic party and President Obama in particular. Polls conducted in the days following the event gave Mr. Obama at 9 percentage point increase in approval. There are a few points to consider on the prediction market's reaction to the event.
First, it definitely increased President Obama's probability of victory in 2012. On average his probability of victory has gone from around 60% to around 63%. Second, both Intrade and BetFair, the two leading markets, took a surprising amount of time "digesting" the information. Today, seven days after the event, they are still moving sharply. Prior to Mr. Obama's press conference announcing the death of Osama, the probability is relatively flat for weeks, but after the event there is a distinct trend in both markets that is still visible. Third, the two markets ultimately disagreed on the trajectory of the "digesting". Betfair is digesting the news by moving even further in favor of an Obama victory and Intrade, from an almost identical position, is moving back toward the pre-Osama death probability of victory. I am not going to discuss here the true underlying value of Osama's death, beyond the values provided by the markets, but I can state that in a few days arbitrage will bring these two markets together and we can have a clearer picture of what the markets feel is the underlying value of Osama's death on the 2012 Presidential election.
There appears to minimal effect on the House. The probability of the Democratic party regaining the House remained flat through the last two weeks.