Betting on Palin

Last Friday was another bad P.R. day for prediction markets as traders failed to bet well in advance that Alaska's Sarah Palin would be John McCain's VP nominee. (It also didn't help that heavy traffic rendered Intrade inaccessbile for many users in the early morning hours.)

Barry Ritholtz said:

Note that her lifetime futures chart is only 3 months old. Forget 18 months ago -- as of 4 months ago, SHE WASN'T EVEN ON THE FUTURES TRADER'S RADAR. Over the life of the contract, she was never more 20%.

Felix said:

...in the final hours or days before a big political result/announcement, prediction markets become less, not more, reliable. I've made this point about the Democratic New Hampshire primary, and it's worth repeating: contra Justin Wolfers, who believes that "in a moderately efficient market today's market price consolidates not only today's wisdom, but also the wisdom of those who traded in the past," prediction markets regularly fail in the feverishness of fluid and soon-to-be crystallized political speculation.

A couple of things.

First on Barry's comment: Palin's contract wasn't the only one that was about 3 months old. The VP contracts for Joe Lieberman and Tom Ridge -- two other favorites at one time or another -- were all that old too. Since we didn't know that McCain was going to be the Republican nominee until March, it makes sense that the contracts are relatively new to reflect his preferences as opposed to Mitt Romney's or Mike Huckabee's.

Second, I tend to agree more with Crossing Wall Street's Eddy Elfenbein:

The political markets work because they can process lots of information very quickly.

It's time to look at news futures markets as the best way we have of crunching available information instead of as oracles. For example, another way to interpret how the Palin contract gyrated Friday morning is to see it through the lens of information dispersion. When you look at it like this, the price movements reflect how quickly traders integrated new information.

Here's a time line that I pieced together on how the Palin speculation spread Thursday night/Friday morning:

Thursday, August 28

8:36 p.m. EST - A Wikipedia user (I.P. address 68.106.201.11) edits Palin's page and adds that she's the VP nominee.

10:47 p.m. - The Red County blog says Palin will be the likely pick.

11:30 p.m. - After Palin's Wikipedia page was re-edited to remove the nominee mention, a Wikipedia user (I.P. address 98.161.55.67) goes in and adds the nominee information again (which is also later removed).

Friday, August 29

3:29 a.m. - Contract for Tim Pawlenty drops from 70 to 52.

By 6 a.m. - Based on three Twitter messages (1, 2, and 3), Palin's contract has by now spiked on Intrade.

7:15 a.m. - Atlantic blogger Marc Ambinder puts up a post showing the flight path of Palin's chartered plane.

8:15 a.m. - Politico's Jonathan Martin follows with similar post.

8:54 a.m. - ABC mistakenly reports that Palin is in Alaska, not in Dayton, OH, where McCain was expected to announce his VP pick.

9:13 a.m. - After the ABC report Palin's contract dives to 12 from a high of 90 at 8:23 a.m., but starts to head north again and is at 39.5 by 9:30 a.m.

9:29 a.m. - The Chicago Tribune names Palin.

10:13 a.m. - Palin's contract at 90.

10:30 a.m. - According to Breaking News or Not, other major media finally confirm the Palin nomination.

The above timeline shows two things: 1) Traders responded quite quickly to the publicly available information. 2) Except in the case of the mistaken ABC news report, most of the information about Palin's VP prospects were reflected in contract prices well in advance of when nearly all major media organizations started to talk up Palin.

Now, the concept of prediction markets as information processors isn't as sexy as the expectation that the markets can divine our future. And the utility of knowing about Palin's good prospects at 6 in the morning as opposed to 9 is minuscule for most of us. But it also doesn't seem quite right to say that the markets are failures.

They're the best mechanism we've come up with for reflecting the available knowledge surrounding an event. Unfortunately in certain circumstances, that available knowledge doesn't go very far. But the beauty of prediction markets is that if you have information which runs counter to the "conventional wisdom" reflected in a contract, there is a monetary incentive to add your point of view.

As for Palin, Intrade has a new contract up on whether she'll resign as the nominee now that the media has gotten a chance to dig into McCain's questionable vetting process. If Palin were to give up the nomination, it would be the first time that's happened since Thomas Eagleton stepped down as George McGovern's running mate in 1972. The contract is trading at 15, meaning there's about a 1 in 7 chance that she'll step down before the elections:

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