The Clinton win in New Hampshire wasn’t only bad for Obama, its also given commentators an opportunity to knock prediction markets. New York Times has a go, as does Slate.

The problem is when the commentators read the markets and deduce that the market is predicting the favorite is the one that will win. However, the great thing about markets is they state the probability with which they make their predictions. And Obama with a 90% chance of winning means that one in ten times he won’t. Desert Vision won the 3:40 at Musselburgh this afternoon. The odds where 25/1 implying around a 4% chance. Does that mean the market was wrong? No, 25/1 shots tend to win around 1 in every 25 races (actually a bit less often due to the bookmakers margin). That just happened to be one of those races.

Basically, the ‘prediction markets where wrong’ commentators are like a bunch of punters at the race track complaining that the market wasn’t right every time the favorite doesn’t win. (In fact they should go to the race track for a probably expensive but very educational day out!)

Chris Masse is diligently following the story at Midas Oracle and the Silicon Alley Insider gives a nice analysis. Of course the only way to measure whether markets are accurate is to look at them over a number of events. Caveat Bettor is keeping the score on the primaries and it is prediction markets 3, Zogby 1 (with one 2-way tie and one 3-way tie).

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In financial markets there is strong evidence to suggest that news gets priced into markets within 15 minutes of its release and sometimes even more quickly. Recent research into prediction markets suggests that they aren’t nearly as efficient with researchers from University of Pennsylvania showing that prices on IEM can be predicted using public news flow.

Doing a simple analysis of some the key events in the 2008 Presidential Elections against prices on Intrade shows that on discrete events there is a clear relationship between prices and news flow. However over longer periods the relationship is not always clear.

On the 4th of March CBS announced the results of a straw poll conducted at the conservative PAC convention in Washington DC. They picked Romney as their favourite. Romney’s price on Intrade lifted immediately where it stayed for about a week.

On the 11th of April the Fred Thompson revealed on Fox News and ABC Radio that he had been diagnosed with non-Hodgkin’s lymphoma nearly three years prior. The New York Times and other publications picked up the story the next day. Looking at his price chart shows he opened on the 12th of April at 19 but then closed at 15. The next day he opened at 11.2 but then closed at 17, as the story died down.

In both these cases, the news stories the media considered to be the important ones correspond with the news flow that traders thought was important.

However, the most interesting market movement of the year must be the Obama August slide. On the first of August Obama opened on Intrade at 35.5 but by the 24th of that month he had slide to 17.2. He continued sliding hitting a rock bottom of 10.7 on the 14th of October. 

The question is what was the news flow on Obama from the 1st of August to the 24th of August? Analysing the news articles in the New York Times suggests a disconnect between what was reported and how the market was reacting. Obama started August badly with a bungled comment on use of nuclear weapons. 

Additionally, his continued line that stabilisation of Iraq had been a ‘complete failure’ may also have cost him some points.

However in sum these news items don’t seem to correlate with an 18 point slide. This could lead us to two possible conclusions:

1. The New York Times didn’t report the most market sensitive news affecting Obama in August
2. Obama was over-sold in August and his price did not reflect his true value

I would love to hear your comments on the analysis in either the comments below or email me to nigel [~at~] hubdub [~dot~] com.

 Nigel

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