10 January 2008

What do prediction markets measure, anyway?

From "The Caucus", the New York Times' political blog:
On Intrade, the online political prediction market, 39 percent are predicting Mr. Obama will be the Democratic nominee, while 57 percent are betting on Mrs. Clinton.
(This is as of intrade's weekly newsletter from yesterday.)

Not so. Intrade users were willing to pay $3.90 for a contract that will pay them $10 if Obama wins the Democratic nomination, and $5.70 for the same contract with Clinton. Most (more than 57 percent) of these individuals probably feel that Clinton is more likely to win than Obama, and if they had to bet on a single candidate would pick Clinton. What the prediction market says is that people believe there is a 57% probability that Clinton will get the nomination. What this means is another issue; does it mean that if we reran the election 100 times, Clinton would get the nomination 57 times? No, because if we reran the election 100 times, people wouldn't show up to the polls. But it does seem to mean that if someone accepted 100 such contracts on different events, paying $5.70 for each of them, they'd expect 57 of them to pay, at $10 each. If they expected less than 57 contracts to pay, then they wouldn't take the bet. (I'm assuming here that expected value is a good way to measure these things. This is probably reasonable here, because neither Clinton winning nor Clinton losing is a rare event.)

In short, the prediction market says that Clinton has a 57% probability of getting the nomination, which is different than saying that 57% of people think Clinton is the most likely to be nominated.

1 comment:

John Armstrong said...

I'm not sure what they predict, but this seems to be evidence they predict something:


You'll love it. It's about baseball :D