Thursday, December 01, 2011

Price Coherence on Intrade

A couple of days ago, Richard Thaler tweeted this:
Intrade prices seem incoherent. How can Newt nomination price soar but Obama win stay at 50%?
Here's what Thaler is talking about. Over the past couple of weeks, the price of a contract that pays $10 in the event that Gingrich is nominated has risen sharply from about a dollar to above $3.50:

Over the same period a contract that pays $10 if Obama is reelected has remained within a narrow window, trading within a ten cent band a shade above $5:

Thaler considers this pattern to be incoherent because Gingrich is widely believed to be a weaker general election candidate than Romney. For instance, in head-to-head poll averages Obama currently leads Gingrich by 5.7%, but leads Romney by the much smaller margin of 1.5%.

But even if Gingrich really is the weaker candidate against Obama under any set of conditions that might prevail on election day, it does not follow (as a point of logic) that a rise in the Gingrich nomination price must be associated with a rise in the Obama reelection price. For instance, a belief among voters that Obama is more vulnerable would ordinarily result in a decline in his likelihood of reelection, but this could be offset if the same belief also leads to the nomination by the GOP of a more conservative but less electable candidate.

This reasoning is consistent with the so-called Buckley Rule, which urges a vote for the most conservative candidate who is also electable. As perceptions about the electability of the incumbent shift, so does the perceived viability of more ideologically extreme members of the opposition. These countervailing effects can dampen fluctuations in the electability of the incumbent. Hence the market data alone cannot decisively settle the question of price coherence. 


  1. Neat. Just like when a central bank is targeting inflation, there should be no correlation between the policy instrument and future inflation.

  2. Exactly... one can think of the Buckley rule as "targeting" electability. Interesting way to look at it.

  3. i would not read too much into it. Accounts cannot be funded from the U.S. (most banks block it). So there is not a lot of liquidity - the bid asks are pretty wide and there is not a very deep market to arb any perceved inconsistencies. Its also hard to get your money out if you are right. Overseas players able to access it do not know much about US politics (I lived in England for a while, many dont get the U.S. governmental system).

  4. dwb, accounts can easily be funded by bank wire or check and most traders on the exchange are in fact from the US. Withdrawal of funds is also easy via bank wire or check. Funds can also be transferred easily between accounts.

    If you look at the intrade forum you'll find over 1400 messages in the thread on the republican nominee alone. Some of these are from highly informed individuals who are intimately familiar not only with the political landscape and polling data but also with details about the apportionment of delegates at each primary. They respond to information rapidly, tracking blogs and twitter feeds as well as traditional media. And the forum reflects just a small subset of traders.

    Regarding liquidity, there's plenty of it. Open interest in Gingrich alone is 170,000 contracts. Spreads sometimes widen when news arrives but close quickly. It's not unusual to see spreads of a penny on a widely traded contract. Overall volume is an order of magnitude greater than on the Iowa Electronic Markets, which have a strong record of forecasting electoral outcomes (better than poll averages for instance).

    All this does not imply that the market is efficient. As I have argued in a previous post, Intrade's high visibility itself creates incentives for manipulation. Shifting prices by a few points can help a campaign and is a lot cheaper than running ads in big media markets. But this kind of thing is what brings the informed traders in.

    All in all, it's an interesting market that ought to be taken seriously.