The Now Economy

Donald Luskin noticed a stock market anomaly, and when he looked for explanations, he found a possibility on TradeSports. On January 20th, the stock market had its biggest one-day drop in three years, but recovered completely over the next few days. Luskin wondered what had caused the short term spike, and didn’t find any reasonable explanations in the financial press. When he looked on TradeSports, he found that the markets on whether the Republicans will keep their majority in the House of Represenatives this fall also had a one-day drop.

Luskin suggests that the increased chances of a change in control of the congress, whatever the cause of that, was probably enough to spook the market. Since the GOP House contracts recovered to their former levels within a few days, he concludes that that scare receded, and that would explain the market’s short term slump and recovery.

Unfortunately for his thesis, Luskin left something out. TradeSports has separate markets for the Republican’s control of the House and the Senate, and the two markets moved strongly in opposite directions. Now it may be that you can explain this away by noting that a change from 69% to 63% in the chances for the Republicans to retain the House is much more significant than a change from 79% to 89% in their chances for retaining control of the Senate, since the former says there is doubt that they will retain control of both, while the latter says it’s still likely they’ll continue to control the Senate.

While Luskin only handwaved about the relationship between the stock market and politicians’ expected behavior, a paper by Wolfers and Zitzewitz found significant correlations between the financial markets and TradeSports’ markets on the chances for war and for Saddam’s capture. Seems like it shouldn’t be too hard to do a similar study now that there are explicit markets on control of the congress.

Koleman Strumpf presented a very interesting paper at the Prediction Market Summit last Friday, so I finally read his article on Manipulating Political Stock Market. It bears on the experiment I am working on with some folks at GMU, since both deal with Manipulating markets. Koleman’s paper looks at three examples, two studies of naturally occurring manipulation attempts, and one controlled study of manipulation on the Iowa Electronic Markets. The most interesting is his study of what actually happened in the Presidential election markets that ran in New York and other major American cities between 1880 and 1944.

The newspapers reported daily prices on election wagers, and also often printed names and amounts bet. From these reports, we can tell that many prominent people in the stock market, business, and politics were visibly betting on the outcomes of political races. The betting volume was quite high: on an inflation adjusted basis, $158 Million in 2000 dollars were wagered on the 1916 race.

Koleman based his study on reports in the papers of charges of manipulation of the exchanges, and compared the prices before and after the manipulations were purported to take place. The study shows that while there may be a short term (1-day) effect from the alleged manipulations, the effects seem to wash out within 2 days.

Koleman goes on to study manipulation episodes on TradeSports, and a controlled study of manipulation on IEM. In both these cases as well, the effects of manipulation are transitory. The IEM manipulations were substantial but not sustained. It’s conceivable that in a market that doesn’t restrict deposits (IEM has a maximum of $500) a partisan could spend a more substantial sum over a longer period and sway the odds. But these studies don’t make it look likely to work.

We shouldn’t be surprised that there was betting on elections 120 years ago. Pope Gregory XIV banned betting on papal elections in 1591. He wouldn’t have bothered if betting hadn’t been rampant. Anyone know of any records of wide-scale election betting before that?