(Bloomberg Opinion) -- Each week brings a fresh batch of polls about the 2020 presidential campaign, but it’s also worth taking a look at the prediction markets. They can be a very useful source of information, most of all as a check on the human tendency to overreact.
Prediction markets — there are several, which allow people to bet on a particular candidate — are a quick way to get an overview of the state of the campaign. President Donald Trump is currently at about 0.40 to be re-elected, which means that it costs about 40 cents to buy a share that pays $1 if Trump wins. Under normal assumptions about the uncertainty of future economic growth, the markets rate Trump’s chances of winning at 40%.
Don’t get too carried away inferring anything about the exactness of that estimate. Still, it is a useful corrective to the argument that Trump is toast — or, alternatively, that he is a shoo-in. The market incorporates the relevant uncertainties in both directions. (Interestingly, Trump’s re-election odds have stayed pretty steady over the last week or so of negative news.) In many cases, prediction markets show greater stability than poll results over the course of an election cycle, as they “see through” the day-to-day volatility that may buffet the polls but not affect the final outcome.
You also will see that Elizabeth Warren is a clear favorite to be the next Democratic nominee. As of this writing, her nomination victory is selling at 45 cents on the PredictIt site. Joe Biden is a distant second at 20 cents. Other prediction markets offer slightly different prices, but the overall picture is broadly consistent.
Compare this picture to the one you get from reading the mainstream media, which tend to view Biden and Warren as locked in a close struggle (and sometimes even leave the impression that Biden is the favorite). Prediction markets have usefully disabused me of that notion. They have also made me think that a possible Hillary Clinton candidacy, while still unlikely, is perhaps an undercovered story.
You may find that notion absurd. But remember: It is not a valid criticism of prediction markets to say that they didn’t predict Trump, say, or Brexit. The purpose of prediction markets is not to foresee particular upsets. They can, however, tell you in advance what would be an upset — much like probability theory can tell you that getting three heads in a row is unlikely but is of no help in predicting exactly when it will happen.
Perhaps the biggest problem with the casual use of prediction markets is that they can overrate the odds of underdogs. For instance, Andrew Yang has been hovering at about 10% for his chances of winning the Democratic nomination (meanwhile Kanye West has a 6% chance of running for president, with Mark Zuckerberg at 4%). I strongly suspect his actual chances are less than that.
Why might the market be wrong here? The most likely hypothesis is that Yang has some supporters who bet on him out of loyalty, much as some sports fans bet on their team regardless. At the same time, there aren’t so many people who want to bet against Yang. This leads to a bias in his favor. Keep in mind that when you put money into these markets, you lock up funds for some period of time, and you run the risk that the intermediary cannot redeem winning bets in a timely manner. That leads to arbitrage — and the accompanying probability estimates will be imperfect, especially for smaller sums in the less liquid markets.
Prediction markets have another potential flaw: They focus attention on clearly demarcated events that are easy to bet on, such as who will win an election or whether Rudy Giuliani will face federal charges. Sometimes these are important matters. Other times they are not.
There are more meaningful trends that are more difficult to measure, such whether Americans are feeling more lonely. These things certainly have an impact on politics, but they are not easy to bet on. Political prediction markets are undeniably useful and very often enlightening, but maybe they should come with a warning: Feel free to check the odds as often as you like, but do not let your obsession blind you to the larger issues at stake.
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Tyler Cowen is a Bloomberg Opinion columnist. He is a professor of economics at George Mason University and writes for the blog Marginal Revolution. His books include "Big Business: A Love Letter to an American Anti-Hero."
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