Futures markets handicap winners of primaries

Speculators beat pundits at predicting election results

Feb 11, 2008 @ 12:01 am

By Jeff Benjamin

Speculators seem to know more than political pundits when it comes to predicting election outcomes.

That is suggested by presidential-candidate futures trading, which is transacted on a somewhat quirky, but surprisingly accurate, market.

"These exchanges were designed to create accuracy, because we're asking people to predict not how they feel but what will happen, which means people have to take things into account other than their personal opinion," said Thomas Rietz, associate professor of finance at the University of Iowa in Iowa City.

For instance, during the past five presidential elections, the Iowa Electronic Markets, also in that city, has been closer to predicting the ultimate winner, 74% of the time, than nearly 1,000 independent polls.

A snapshot of the market Thursday morning showed futures favoring New York Sen. Hillary Clinton for the Democratic nomination, priced at 42.1 cents per share.

OBAMA FAVORED

At the same time, Sen. Barack Obama futures were trading at 56.8 cents, suggesting that the market favored the Illinois senator to win the nomination.

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On the Republican side, Arizona Sen. John McCain futures were trading at 93.3 cents, while former Massachusetts Gov. Mitt Romney, who suspended his campaign last Thursday, were trading at 3 cents.

Arkansas Gov. Mike Huckabee futures were trading at 1.7 cents on the exchange.

Based on those contracts, it would appear that the market is singling out Mr. McCain as the overwhelming favorite on the Republican side.

That was the case leading up to the Feb. 5 Super Tuesday vote, when 24 states held primary elections. Despite political navel gazing about Mr. Romney's chances of gaining ground in the race, traders had held Mr. McCain's contracts above 80 cents since Jan. 30.

While some advisers and professional traders shrug off the so-called predictive markets as gambling or pure entertainment, it is difficult to dispute the data showing that such markets have been more accurate than a broad range of independent polls in predicting the outcome of presidential elections.

In 1992, the polls and pundits missed the impact of Ross Perot's running as an independent along with Republican incumbent George H.W. Bush and Democrat Bill Clinton, Mr. Rietz said.

"The polls all missed it by projecting that the independents would go for either Mr. Bush or Mr. Clinton, but the markets got it that Mr. Perot would take a share of the vote," Mr. Rietz said.

Another example of the market's ability to predict accurately came in 2004 when early exit polls favored John Kerry over incumbent George W. Bush. The futures markets, meanwhile, held steady for the latter as the ultimate winner.

The Iowa Electronic Markets, which is the oldest predictive market and the only one operated inside the United States that trades in real money, was created by the University of Iowa in 1988 as a research tool and continues to be run as a not-for-profit enterprise.

Part of the strength of the exchange as a forecasting tool is attributed to the influence of human nature, Mr. Rietz said.

"People who are biased one way or another for a particular candidate tend to buy and hold," he said. "But it's the people who trade continuously that set the market."

The best example of this has been illustrated throughout the Democratic primary, where contracts for Mr. Obama and Ms. Clinton have bounced around like technology stocks.

While Ms. Clinton's contracts traded at an average price of 55.1 cents each through the first six days of February, her contracts dipped to below 35 cents on the evening of Feb. 5 when the results from Super Tuesday's primaries started to come in.

Mr. Obama's contracts, by comparison, have averaged 44.9 cents over the same period but swung well ahead of Ms. Clinton on Super Tuesday.

Also, Mr. Obama's contracts have continued to gain on Ms. Clinton since Super Tuesday.

For traders, the appeal is rarely the prospect of big financial gain, since the Iowa exchange limits accounts to $500.

The political-futures marketplace, however, does appeal to some advisers.

"I think it can be a good gauge of where things are going, and it's a pretty efficient marketplace," said Louis Kokemak, a sole proprietor operating as Haven Financial Advisors in Austin, Texas.

Mr. Kokemak, who has $20 million worth of client assets under advisement, also has "about 50 bucks" of his own money at risk on a Dublin, Ireland-based futures ex-change, InTrade.com, where he holds contracts favoring a Republican win in the general election in November.

The payoff for a presidential primary is determined when a party makes the nomination official. At that point, contracts for that candidate adjust up to $1, while all other contracts adjust down to zero.

"It's more of a hobby than anything else for me," said Jonathan McGrain, a 44-year-old independent marketing consultant in Richboro, Pa.

"My trades don't reflect the candidate I'm most interested in," he added. "The biggest fool is the person who thinks they've figured it out."

The small size of the market, with average daily trading volume during the primary-election period of 3,100 contracts and a value of about $600, is partially by design.

The Iowa exchange received a no-action letter from the U.S. Commodity Futures Trading Commission in Washington in 1996 enabling it to operate under limited regulatory scrutiny up to a certain size.

One of the CFTC's stipulations is that the exchange does not charge transaction fees.

"Some of the traders just find it relaxing or they are very interested in politics, and they like matching wits against others," said Joyce Berg, director of the Iowa exchange and associate professor of accounting at the university.

"I think some of the traders also like the idea that they're involved in this research project," she added. "It somehow gives them a sense of social good."

Jeff Benjamin can be reached at jbenjamin@crain.com.

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