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Thursday, August 6, 2015

Prediction Markets and Donald Trump

I've written about prediction markets before ("Election Update"). They are not popularity polls. Instead they are speculative markets where people "bet" on various outcomes (e.g., who will win the next Presidential election, whether the economy will go into a recession by December 2016, whether the Royals will win the World Series, and so on). People are rewarded for making accurate predictions and punished for making inaccurate ones, which is why they tend to be better at predicting outcomes than most polls. Why? Because with polls people often engage in wishful thinking; however, when they bet, they're more likely to put their money on the outcome they think will win (even if it's for one they don't want).

The way it works is that if you buy 10 shares of, say, Hillary Clinton winning the 2016 Democratic nomination for $7.78 (the current price on Betfair), then if she wins, you'll receive $10.00 and make $2.22. The current price of a share is interpreted as the probability that the outcome will occur. In other words, the prediction markets currently give Hillary a 77.8% chance of wining the Democratic nomination. That doesn't mean she'll receive 77.8% of the vote. It only means that she has a 77.8% chance of winning.

What does this have to do with Donald Trump? Although much has been made of his rise in the polls, there has not been a corresponding rise in the prediction markets. Just before tonight's debate, his share price for winning the Republican nomination climbed to as high as 10.0% but still trailed Jeb Bush and Scott Walker. Since the debate, his share price has dropped to 6.0%, and he now trails Jeb Bush (42.0%), Scott Walker (18.0%), and Marco Rubio (11.0%) ("2016 President - Republican Nomination"). Prediction markets aren't flawless, but right now, things are not looking good for Mr. Trump in spite of all the attention he is getting.

Note: Overnight, Trump's share prices rebounded to pre-debate levels before falling back to somewhere between 5.0% and 7.0%, which leaves him in fourth place behind Marco Rubio. He is in danger of being overtaken by John Kasich, who several people seemed to think "won" the debate among the so-called top-ten candidates, and Carly Fiorina, who almost won the earlier debate among the other candidates.

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