Risk Markets And Politics

Sunday, November 12, 2006

Political Factor Analysis

David Pennock, Lance Fortnow and others on Marginal Revolution and DailyKos explain the "failure" of prediction markets for Senate control as stemming from the assumption that state-level elections are independent events, an assumption that ignores national movements in sentiment.

Is there a way to test this idea? If a general anti-Republican/pro-Democrat wave swept across the country, decreasing the independence of individual elections, it might be expected that those Republicans who best represented the party line would fare the worst compared to what prediction markets and polls projected.

Voting records such as those available at the Washington Post can serve as a simple proxy for how representative members are of their given party. A legislator will be "typical" if their votes nearly always correspond to their party line. Now do the electoral fortunes of legislators who are more typical in this sense in fact exhibit a higher "beta" to general sentiment shifts? If (possibly after trimming special cases) this did not appear to be the case in the last election — if prices were not worse in proportion to how typical the Republican candidate was, then the lack of independence explanation is suspect. In that case, no explanation should be required either, since after all, 70% != 100%.

This is only a first pass, as an issue-level factor analysis should be more enlightening than one that remains at the party-level. This would also allow us to take the challengers' views into account when modeling individual races.

In terms of the "defense" of prediction markets, apparently it needs to be pointed out ad nauseum that the question is not about their absolute success, but their success relative to alternate tools. Empirical findings confirm the superiority of prediction markets to polls, and the logic of motivation is clearly in their favor. In terms of anecdotal evidence, consider these opinions submitted in response to a television survey on confidence in polls conducted on 11/5/06:
I tell the pollsters the exact opposite of what I'm planning to do. It's none of their business anyway.
Carole, Columbus, OH

I don't believe in polls. I keep a penny by the phone. 'Heads I'm a Democrat, tails I'm a Republican.' I like to keep them guessing.
Tom, Seattle, WA
Maybe polls should be more emotive and oblique, and ask questions like, "What issues anger you the most?" and "What issues most affect your day-to-day life?". Prediction markets would then be able to digest this data and better gauge the independence of elections.

In any case, both political factor data and analysis techniques will see development before the 2008 elections. On the latter side, this will include working through ambiguities and accounting for correlations in issue preferences (which constrain party platform "optimization").

[Cross-posted to Midas Oracle]


  • Brad DeLong also advocated a dispersion trade in the midterm election markets: "I just heard it claimed that--until the first trade moves markets, volume is low--that there is an open dispersion trade on tomorrow's House election at Tradesports: go long the individual Democrats and hedge it by going long the generic Republican" (source: http://tinyurl.com/y6lb8p)

    (Flashback: LTCM dispersion trades ... "Knowing that many high-tech companies issued puts cheaply to mange their employee stock-option programs, Long-Term bought heaps of these puts, issued by companies such as Microsoft and Dell, and hedged them by selling puts on the S&P 500." -- From Roger Lowenstein's "When Genius Failed")

    By Anonymous John, at 1:23 PM  

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