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Leighton Vaughan Williams is director of the Betting Research Unit and director of the Political Forecasting Unit at Nottingham Business School, Nottingham Trent University.

This article appeared in the Nov. 26, 2007, edition of The Polling Report.


How to Forecast an Election

(And How To Win One!)

by Leighton Vaughan Williams


My first personal experience of the relative merits of opinion polls and betting markets in forecasting the outcome of an election occurred in 1985 in a by-election called to fill a vacant seat for the UK Parliament. The by-election was taking place in a rural corner of Wales in a constituency called Brecon and Radnor. The key players were the Labour and the Liberal candidates. On the day of the election a poll was published in the Daily Mirror newspaper, commissioned from the MORI polling organization. This gave the Labour candidate a commanding 18% lead over the Liberal. Meanwhile, a short walk to the local office of Ladbrokes, the leading bookmaker, found a rather different picture. The odds-makers were making the Liberal the odds-on favorite with the Labour candidate the relative longshot. The late-breaking MORI poll did nothing to change the price. Who won? It was the Liberal, of course, and those who followed the money.

Indeed, it seemed to me even then, well before I studied the subject in any depth, that people's responses to opinion polls are very sensitive to the form and structure of the questionnaire and that the validity of the findings are even more sensitive to the sample of voters taken and whether those surveyed are likely to vote. Meanwhile, decisions backed by hard-earned money are likely to be very carefully considered and to weigh and discount relevant and irrelevant information in a serious and appropriate fashion.

That’s the theory at least. The most convincing point, however, was that the market had done so much better a job of predicting the election result than the trusted pollster. It was several years before I realized that what applied to the small rural backwater of Brecon and Radnor applied equally well in a study of every U.S. presidential election between 1868 and 1940. In only one year, 1916, did the candidate clearly favored in the betting the month before the election end up losing, when Charles Evans Hughes lost to the incumbent, Woodrow Wilson, in a tight race. (See “Historical Presidential Betting Markets,” Paul W. Rhode and Koleman S. Strumpf, The Journal of Economic Perspectives, Vol. 18, No. 2, Spring 2004, pp. 127-141.)

The power of the betting markets in assimilating the collective knowledge and wisdom of those willing to back their judgment with money has only increased in recent years as the volume of money wagered has risen dramatically. Indeed, by 2004 the Intrade market model went stratospheric in predictive accuracy as the market favorite won the electoral votes of every single state in that year’s U.S. presidential election. Meanwhile more than one respected pollster and analyst called the race for John Kerry as late as election day itself.

The betting markets saw their best triumph of 2004 in Florida. Even though a number of polls put Kerry ahead in that state, or said the race was too close to call, the betting markets consistently showed Bush would win Florida comfortably.

Indeed, if the Democrats had paid as much attention to the markets as the polls, I am convinced that the election result would have been different. They could have downsized their effort in Florida and focused their efforts more on other swing states where betting sites showed the race was much closer.

Intrade followed up in 2006 when the market favorite won each and every Senate seat up for election. Moreover, in large part the stronger the favorite, the bigger was the margin of victory.

Follow the Money
The assumption, or at least the hypothesis, must be that the accuracy of the betting markets is created out of the information and intuition of many people rather than the conclusions of a few. Those myriad people feed in the best information and intuition they can because their own financial rewards depend directly upon them. And it really is a case of “follow the money” because those who know the most are likely to bet the most.

Moreover, the lower the transaction costs (there is no tax on betting in the UK) and information costs (in never more plentiful supply due to the Internet) the more efficient we might expect betting markets to become in translating information today into forecasts of tomorrow. The rise in the importance of person-to-person betting exchanges like Betfair offers another reason why the markets are becoming ever more efficient in predicting the future. These exchanges differ from traditional betting markets by eliminating the odds-setting bookmaker, instead providing the technology to match up the best offers to back and lay an outcome on offer from all the clients of the exchange. In so doing they ensure that the margins implicit in the odds are lower than they have ever been. For all these reasons, betting markets today are likely to provide better forecasts than they have done at any time in history.

Buoyed by this enthusiasm for the power of market forces I was sufficiently confident, when asked by The Economist magazine, to call the winner and the seat majority in the 2005 British General Election over two weeks out. My prediction of a 60-seat majority for the Labour Party, repeated in an interview on the BBC Today program was challenged in a BBC World Service debate with the chairman of the MORI polling organization. He wanted to bet me that his figure of a Labour majority of over 100 was a better estimate. I declined the bet and saved him some money. The Labour majority was a little over 60 seats.

In October of this year The Economist ran a follow-up article on election betting, asking me the likely outcome of the British General Election if Prime Minister Gordon Brown, then actively considering his options, decided to ask the Queen for the requisite dissolution of Parliament. After consulting the markets, I declared his odds of a majority just slightly better than even. “So,” I asked, “is the Prime Minister willing to risk his majority on the toss of a coin?” The answer was no.

Low-Volume and Play-Money Exchanges
This is not to say that all betting markets are always right. The Iowa Electronic Markets have been allowing selective trading for modest amounts of money on their exchange since 1988, with some success. Nevertheless, their odds were far off the mark in the 2000 election, predicting that Mr. Bush would win a larger share of the popular vote than Mr. Gore (meanwhile, the real-money “spread betting markets,” available to significant trading volume in the UK, had the electoral winner priced up as a dead-heat). Moreover, the Iowa markets failed to predict the Republican victory in the Senate in the mid-term elections in 2002 and have struggled to maintain their foothold at the top end of predictive accuracy since the rise of the high-volume exchanges. Perhaps this is because Iowa's markets keep bets to a small size, which puts less pressure on traders to get their predictions right. Perhaps it’s a blip. Time will tell and these low-volume markets, as well as play-money exchanges such as Newsfutures, continue to command respect.

Forecasting elections is not simply a matter of comparing the accuracy of polls with betting markets, however. There is a sizeable literature on the value of econometric models, which take account of such factors as employment, inflation, interest rates, incumbency, in predicting election outcomes. Other methodologies include various ways of weighting the opinions of political scientists, political journalists, political pundits and experts of other stripes, in forecasting the winners and losers.

In my book, Information Efficiency in Financial and Betting Markets, published in 2005 by Cambridge University Press, I employed a blind “moment-in-time” case study, conducted exactly a month before the 2004 U.S. presidential election, to compare and contrast the forecasts implicit in each method. I was left with least confidence in econometric models and most in betting markets, which is what I expected.

One interesting angle, though, is whether a combination of one or more of these methodologies, weighted in one way or another, can do better than any individual forecasting methodology. Just as interesting is the extent to which the accuracy of forecasts derived from election betting markets is affected by altering the structure of the market. For example, is the accuracy of these forecasts affected by the nature of rewards within these markets -- whether participants use their own money or “play money” to make trades in the prediction market; is it for example affected by whether artificial limits are placed on the amount of money used by market participants to trade? More generally, to what extent is the accuracy of forecasts derived from election prediction markets affected by altering the structure of the prediction market?

The bottom line, therefore, is not to assume that betting markets provide all the answers, though sometimes it seems like they do. We must always be looking to improve our predictions. And when the markets do fail, we must not be afraid to ask why. When these prediction markets succeed, we must also ask why, and whether they could do even better.

These questions and more are at the forefront of two new journals, published by the University of Buckingham Press, namely The Journal of Prediction Markets and The Journal of Gambling Business and Economics.

On recent evidence, then, some markets have seemed so powerful in predicting election outcomes that one might be forgiven for bothering to turn out to vote at all. Of course, that makes no sense. What does make sense, however, is that political operatives need to pay more attention to the markets in planning their election strategy. If those close to Mr. Kerry had listened to this advice in 2004, the senator from Massachusetts would in my convinced opinion now be President Kerry. Any sophisticated campaign needs to make sure that it doesn’t repeat that mistake.

For those who want to know more, the Betting Research Unit at Nottingham Business School, now linked to the newly-formed Political Forecasting Unit at the same institution, is just an e-mail (leighton.vaughan-williams@ntu.ac.uk) away.

In conclusion, recent years have witnessed groundbreaking shifts in the way in which betting is taxed, regulated and perceived by economic theorists. This means that betting markets will become more than just a major part of our future. Properly utilized they will be able to tell us what that future is likely to be! We seem therefore to have created, almost by accident, a “high-tech” crystal ball that taps into the accumulated expertise of mankind and makes it available to all. The challenge now is to make the best use of it.

Copyright © 2007 POLLING REPORT, INC.

The power of the betting markets in assimilating the collective knowledge and wisdom of those willing to back their judgment with money has only increased in recent years as the volume of money wagered has risen dramatically.

 

 

 

 

 


 

 

 

 

 

[I]t really is a case of “follow the money” because those who know the most are likely to bet the most.

 

 

 

 

 


 

 

 

 

 

[P]olitical operatives need to pay more attention to the markets in planning their election strategy. If those close to Mr. Kerry had listened to this advice in 2004, the senator from Massachusetts would in my convinced opinion now be President Kerry.

 

 

 


 

 

 

We seem therefore to have created, almost by accident, a “high-tech” crystal ball that taps into the accumulated expertise of mankind and makes it available to all.

 

 

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