Prediction Markets: A Probability is not a Certainty

Mark Gongloff has a rather silly attack on prediction markets today. Let’s start at the beginning:

John McCain’s presidential campaign is doomed — at least, if you still believe what political futures markets indicate.

At the Irish electronic exchange Intrade, on which people bet on election outcomes and other events, the futures market suggests Mr. McCain has a 38% chance of becoming the 44th president. In the Iowa Electronic Markets, set up at the University of Iowa, Mr. McCain’s Republican Party gets a 41% chance of winning the popular vote for the White House.

Um, a 40% chance of winning means that McCain is doomed? No, it means he has a pretty good chance of winning, just not better-than-evens.

Then again, six months ago, the Iowa markets gave Barack Obama less than a 30% chance of winning the Democratic nomination.

Well, I guess that if 40% is doomed, then anything less than 30% must mean no chance at all. Did it not occur to Gongloff that six months ago there were three major contenders in the Democratic race? You’d expect Obama to be on or about 30% at that point.

Academic studies suggest these markets are more reliable than opinion polls, but that might be giving the markets too much credit.

No, that would be the conclusion you draw from actually looking at the numbers. Note Gongloff doesn’t point to any flaws in the academic studies.

Intrade futures had John Kerry beating President Bush well into the evening of Election Day 2004. They also said there was a good chance Mr. Obama would top Hillary Clinton in January’s New Hampshire primary, which she won.

The Kerry-Bush election was incredibly close. In the futures market, it just so happened that Kerry was trading above 50% while Bush was trading below 50%. There’s a world of difference between a candidate trading at 55%, say, and a candidate trading at 95% – but Gongloff doesn’t seem able to make that distinction.

What’s more, there’s a huge amount of noise in the final few hours of any election. If you look at Hillary’s New Hampshire numbers over the weeks leading up to the primary, she was the favorite to win all along – and then there was a bunch of crazy volatility at the end.

The people who bought Rudy Giuliani presidential futures had no better insight than the people who bought Yahoo at $100 a share.

True dat. But no one’s claiming otherwise.

Mr. McCain does have a tough row to hoe. But his futures price clearly isn’t the final word on this election.

And, once again, no one’s claiming otherwise. The prediction markets give a good indication of how difficult McCain’s task is. And what they’re saying is that he can win, he has a pretty good chance of winning, but that on balance it’s probably more likely that he’ll lose. Does that seem outlandish to you? It doesn’t to me.

It’s a bit annoying to see the same meme trotted out over and over again with respect to prediction markets. Every time a prediction-market favorite loses, the likes of Gongloff start crowing: Look! The markets were proved wrong!

But let’s say there are ten elections, in each of which there’s a 60% favorite. Run them all, and you’d expect four of them to go against the favorite. Indeed, if the favorite won in all ten elections, that would be a much greater mark against prediction markets than if the favorite lost in a few of them. It’s not a hard concept to grasp – so why do so many pundits fail to get it?

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