What are they betting on?

My friend and undergrad classmate Erik Simpson has been following an interesting trend on Intrade, the prediction market that allows predictive “bets” on realworld events. Specifically, Intrade’s prediction results were diverging from other predictive models, specifically those of fivethirtyeight.com. More research dug up the interesting fact that Intrade doesn’t agree with other predictive markets either. Yesterday Erik followed up these posts with the logical question: why not simply arbitrage the difference? If Intrade and the Iowa Electronic Markets are really efficient markets, there should be no persistent price spread, but since there is a price spread there’s an opportunity to make risk free money by selling on IEM and buying on Intrade, then reversing the trades after the election, when the outcome is locked. (As of this writing, Intrade has a 70% probability of Obama winning, vs. a 74.9% chance on IEM.)

The persistent difference in value can be explained by one of two market frictions: either there are one or more irrational actors who are making trades based on something other than rational economic decisions, or there is information asymmetry: the trader knows something that we don’t about the outcome of the election. I’m inclined to think it’s the former. But I don’t rule out the latter, for the reason that the GOP and its followers are starting to scare the hell out of me (anyone else wonder why someone shouting “Kill him” at a GOP rally wasn’t immediately brought in for questioning by the Secret Service?).

It’s not hard to see why the GOP might be frustrated at this point. The Democrats have done a superb job of keeping their powder dry, waiting until McCain really stepped up the smears to point out that he has deep roots in banking and real estate corruption through his membership in the Keating Five. This campaign has refused to roll over and play dead while smears and attacks were directed at them, and while they’ve played hard in return, it’s been to point out how McCain and Palin have specific unsuitabilities to deal with the issues in front of the country right now.

The downside of this campaign–one of the few really well contested matches we’ve seen in recent years–is that it doesn’t leave much room for discourse on the issues. I’d love to see Obama clear enough of the smoke to start talking about how we get out of this mess, but I think he’s going to be facing enough crap for the next few weeks that we won’t hear substantive proposals for a while.

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