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Polls vs. Prediction Markets

- January 2, 2008

Andrew Gelman responds to Justin Wolfers’ piece in the Wall Street Journal on the superiority of these markets for forecasting election outcomes. Andrew refers to this paper by Robert Erikson and Chris Wlezien:

bq. Election markets have been praised for their ability to forecast election outcomes, and to forecast better than trial-heat polls. This paper challenges that optimistic assessment of election markets, based on an analysis of Iowa Electronic Market (IEM) data from presidential elections between 1988 and 2004. We argue that it is inappropriate to naively compare market forecasts of an election outcome with exact poll results on the day prices are recorded, that is, market prices reflect forecasts of what will happen on Election Day whereas trial-heat polls register preferences on the day of the poll. We then show that when poll leads are properly discounted, poll-based forecasts outperform vote-share market prices. Moreover, we show that win-projections based on the polls dominate prices from winner-take-all markets. Traders in these markets generally see more uncertainty ahead in the campaign than the polling numbers warrant—in effect, they overestimate the role of election campaigns. Reasons for the performance of the IEM election markets are considered in concluding sections.

I will make one additional point, about this passage from Wolfers’ piece:

bq. More recently, in the 2004 primaries, prediction markets pointed to the disintegration of Howard Dean’s candidacy in advance of the fateful Iowa caucuses.

This is true, but it is also true that the polls showed this as well. See this post from Mark Blumenthal. In the polling from the week before the 2004 Iowa caucus, Kerry led in 6 of 7.