Trying to use prediction markets to forecast the presidential election

On InTrade, a typical asset pays $10 should a candidate win the election. While the secret remains hidden, suppose the price of the Democratic candidate asset is $2, indicating a 20% chance winning. If the close friend buys these now and holds them until the secret is revealed he can make a killing when the price rises to say $6. And the more assets he buys the bigger the payoff. However, the act of buying large numbers of these assets will in itself push the price up. In this way the market price comes to reflect all the relevant information regardless of whether that information is publicly known or not.

So what do the prediction markets say about the upcoming election? Despite Bickers and Berry's prediction of a big Republican win, Romney shares are selling on Intrade now for 43 cents on the dollar, indicating a roughly 43% chance he will win the election this November. Prices on the IEM are almost identical.

Romney may yet win the election, but people who have real money at stake are giving Obama better odds of winning, at least for now.

Of course, if you feel they're wrong, you are certainly free to buy as many of those undervalued Romney shares as you want.

Kerk Phillips is an associate professor of economics at BYU.