Election Futures Market
July 17, 2000
Economics offers two distinct approaches to predicting election outcomes. One has its roots in macroeconomics, examining how national economic performance affects voting. The other is grounded in microeconomics, using a real financial market in which participants place bets on the election results.
Using the first approach, Ray Fair, a Yale University economist, examined all two-party presidential elections since 1916. His most recent forecasting model, which involves variables like economic growth, the inflation rate and candidate incumbency, got only two elections wrong when applied to the period 1916-1992.
Some researchers at the University of Iowa have taken a quite different approach. The Iowa Electronic Market has issued securities for the Democratic, Reform and Republican parties tied to the popular vote.
- It has forecast the correct outcome of every election since 1988.
- It even worked for the 1992 three-party race, which caused virtually every other forecasting model to fail.
- And the market has done better than the polls.
The Iowa researchers say this is due to "marginal traders" who are especially sophisticated participants, measured by their trading strategies.
- Such traders tend to have twice as much invested as others, realize a much larger rate of return on investments and participate much more frequently.
- In other words, the marginal traders are professional speculators who trade frequently, methodically and profitably.
The market forecasts are better than the polls not only because the participants have to put their money where their mouth is, but because the market itself gives extra weight to the more calculating participants. That's because the smart money is what moves the market.
Source: Hal R. Varian, "Mixing Economics and Political Science at Universities," New York Times, June 29, 2000.
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