Presidential Election

Just before it was announced that a woman and her attorney, Gloria Allred, would be holding a press conference Monday, the prediction markets gave Cain a 6.8 percent chance of becoming the Republican Party's presidential nominee. By the time the press conference ended, Cain's chances in the prediction markets had dropped to 3.8 percent.

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Gingrich is now the third most likely Republican nominee--still way behind Romney, but just behind a still falling Perry. Thanks to his tenure as House Speaker, Gingrich is the most thoroughly vetted of all of the potential nominees. Of course, Americans have notoriously short-term memories when it comes to politics; Gingrich resigned in 1998 amid very low popularity following the government shutdowns of 1995 and 1996 and the perceived hypocrisy surrounding the Monica Lewinsky scandal and President Clinton's impeachment. You can still expect his far from scandal-free personal life to be a major issue for the religious right as social conservatives weigh his candidacy going forward.

Yet, despite such baggage, the good news for Gingrich is that the field of likely anti-Romney candidates is steadily thinning--leaving him the likeliest candidate for reconsideration among conservative GOP voters. Ron Paul is a libertarian and while he has maintained consistent support and attracted a passionate following, he has not broken into the mainstream of Republican conservatism. Jon Huntsman has been running as a moderate, gaining no traction with the Republicans. And Michelle Bachman and Rick Santorum have positioned themselves as hardline conservative candidates--in a way that has so far prevented them from garnering serious support outside the social-conservative camp.

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I posted a blog piece on Yahoo on the likelihood of President Obama's re-election (which is currently at 50.9%). Click Here for Full Text. As you can see, as bad economic news has arrived over the last few months, Obama's re-election likelihood has also plummeted.The chart is here:

Obama Re-Elect

and the real-time table is below:

 

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.

 

Explaining the Favorite-Longshot Bias in Prediction Markets

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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?

 

Huckabee and Trump Depart the Race

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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.

Prediction Markets Working Well on Republican Nomination

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Three recent polls have come out in regard to the Republican Presidential Nomination. These polls by CNN, Fox, and NBC have Donald Trump in first, third, and second respectively. Further, they have Mitt Romney in fourth, second, and first respectively.

Imagine that there is three types of information about the current field of Republican candidates: first is known to the average Republican voter, second is known to political informed people, and third is unknown. An example of the first type of information for Trump is that he is a popular TV personality and for Romney that he is a former governor of Massachusetts. An example of the second type of information for Trump is that his business affairs and personal life are very rocky and for Romney that he was an extremely successful businessman. The third type of information is all of those things that will happen between now and Election Day, for which is unknown.

In short, differences between poll-based and prediction market-based forecast of who will ultimately win the Republican nomination hinge heavily on the second type of information: information that political informed people in the prediction market know and the average Republican voter does not know now, but will know on Election Day. In this situation, that type of information is generally neutral or positive for Romney, Tim Pawlenty, and Mitch Daniels, but negative for Trump. That is why although Trump is trending second in the polls of today, the self-selected politically informed people who gamble in the prediction markets have Trump as the fourth most likely person to get the Republican nomination. They are betting that the public will learn what they know about Trump and then become less likely to vote for him, relative to the other candidates.

Mrs. Palin's Political Trouble from Saturday's Massacre

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Immediately in the aftermath of Saturday's assassination attempt on Congresswoman Gifford, that resulted in the death of six people including a federal judge and a nine year old girl, the media began speculating on the political fallout to Sarah Palin's 2012 Presidential aspirations. In March she had put out an advertisement with a target on Congresswoman Gifford and then told asked that her followers "Don't Retreat, Instead - RELOAD!" Thus, after the massacre people began to discuss her contribution to both the specific target and the general heated atmosphere in politics; regardless of her complicity, and thus far there is no direct evidence the assassin followed Mrs. Palin, talk of it has political consequences. As several blogs have already noted, the market for her 2012 Republican nomination responded immediately ... on Intrade. She lost over 1/3 of her probability in the immediate aftermath of the massacre. Yet, the movement a different market, Betfair, was much smaller, as it was already trading lower for Mrs. Palin; Betfair has consistently had less confidence in Mrs. Palin's viability as the Republican nominee. The chart is below:

 

Obama and the 2012 Nomination ...

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When you think about 2012 Presidential nominations you are likely thinking about Palin, Romney, and the Republicans. But, as the year comes to close and the 111th Congress end on December 17th or so, I urge you keep an eye on the Democratic ticket. An editoral in today's Washington Post urges a Democrat to run to the left of the President to force him to hold firm on taxes, war, and social issues. First, it would be difficult for Biden to do that from within the adminstration and Clinton is not that person, thus for this to happen it would have to be an outside option. We will make sure to add that person, and you will see it coming with Obama falling. Second, notice the discrepencies between Betfair and Intrade  on Hillary and Biden.