That the Democrats would retake control of the House of Representatives was not surprising to most people. That the Democrats would win enough seats for a Senate majority was a victory that surprised many political experts. It also surprised a lot of Intrade traders: the Senate.GOP.2006 contract market said that Republicans would retain control of the Senate -- or did it?
It's important to remember that such contracts never predict absolute outcome, but rather the pure probability of the event occurring. A probability is not just a percentage chance, but a prediction that if the election is performed an infinite number of times, if the die is rolled an infinite number of times, etc., then a particular outcome will occur that percent of the time.
If an event has (or is predicted to have) a 90% probability of occurring, it may be extremely probable that it will, but keep in mind that it is still not absolute. A hundred-sided die has a chance of coming up with any one desired side as opposed to the other 99: on any particular roll, any side can come up. Then we delve into conditions of much lower probability, such as the high 50s that the Senate.GOP.2006 contract saw in its last hours: those odds are not significantly better than a coin toss, because the chances of the event not happening are still in the 40s and quite good. With a five-sided die, there's quite a good chance that you'll get sides 1 or 2, as opposed to the other three.
In the end, the Senate.GOP.2006 contract did not predict the correct outcome, but each of the 33 individual Intrade Senate contracts correctly predicted the winner. That in itself is great success, and another feather in prediction markets' cap.
It would not suffice that he be Schumpeterian in calculating the risk: he must be also be Kirznerian in noticing (in fact, being able to notice) the opportunity for profit. Once cognizant of what the individual Senate contracts were predicting, he could trade against the favorite in Senate.GOP.2006. That also occurred in the parlay contracts combining the overall House and Senate races, not judging by the contracts' prices, but by the volume.
I noted in our Election Day edition that over 1900 contracts of GOP.House.GOP.Senate had been traded, with nearly 1800 of Dem.House.GOP.Senate, a very surprising 750 of GOP.House.GOP.Senate, and over 2500 of Dem.House.Dem.Senate. The favorite to expire at 100 was Dem.House.GOP.Senate, which closed at 57 on the night before but that's not such a strong probability. So like the Senate.GOP.2006 contract, these parlay contracts also did not predict (this time) that the Democrats would win back control of the Senate.
However, consider that over 30% more contracts of Dem.House.Dem.Senate were sold than either GOP.House.GOP.Senate and Dem.House.GOP.Senate. I dismissed it at the time as the contract merely being "interesting" to traders, but hindsight (perfect as always) lets us conclude that someone traded on the general contracts based on the individual contracts.
My personal conclusion is that some people correctly expected Dem.House.Dem.Senate to be the contract to expire at 100, and whether they were buying or selling contracts, the price stayed down. Presumably others were applying the general contract to the specific ones, rather than the specific to the general. So the successful traders exploited (which is not inherently a bad word) others' expectations that later proved erroneous, in a perfect example of asymmetrical information, "the market for lemons," "buyers as suckers," whatever you'd like to call it.
Perhaps this is too easy an explanation, and it's true that this is only one general contract out of six. Nonetheless, this is why I like to look at volume as well as price, particularly after some news that might affect a contract. Even if prices stay about the same, higher volumes indicate that someone knows (or at least suspects) something. In the movie "Trading Places" when the Duke brothers continually bought though the price kept going up, one trader noticed and said to his associate, "Let's get in on it!" The wonderful thing about this market system is that no one is ever coerced into buying or selling; all participants are fully willing, and the winners are those who can compete best. Brute strength does not factor into the competition, and merely acquiring better information does not guarantee success: one must be able to analyze it astutely.
Chart sources: http://www.intrade.com/
intrade is the leading prediction market for politics, current events, and other related trading categories. Established in 2000, intrade offers trading and predictive data services to a growing community of 70,000 members, journalists and academics. Predictive information from the intrade exchange has consistently outperformed traditional opinion polls. intrade may be reached at 'press@intrade.com', or by calling +353 1620 0300.
Perry Eidelbus is a freelance writer for intrade. Perry may be contacted through eidelbus@gmail.com.
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