Maryland startup hopes to profit from growing political prediction

Dori Berman

Think you know who's going to win the governor's race in November? Would you be willing to put money on it?

A growing number of political prediction markets - operating on both real and fake money - allow you to do just that. And a Maryland startup hopes to profit from the trend.

Political stock markets have operated in the United States for more than a century and recently have made a resurgence, allowing political junkies to bet on presidential, gubernatorial and congressional race outcomes.

Debates abound in the academic world about how well the markets predict outcomes compared to opinion polls, but most experts seem to agree the markets are here to stay this time around.

Rick Hinton formed his Gaithersburg-based company, Red Hill Group, hoping to profit from the growing interest in prediction markets for everything from politics to the avian flu. He planned this week to launch his first Web site, www.casualobserver.net, a political market allowing players to "invest" fake money (for legal reasons) in gubernatorial and senatorial candidates in the nation's most competitive races.

"The site is basically designed to allow individuals an alternative means to track political campaigns," Hinton said. Users can purchase candidates' stock at no charge. The Red Hill founder plans to draw revenue from advertising.

Political markets tend to attract users ranging from campaign staffers and insiders to average voters with an interest in politics, Hinton explained.

"The whole key is to aggregate all of these opinions and expertise and knowledge in one place, and what's typically shown is you get a pretty good result," he remarked.

The longest running market currently in operation, the Iowa Electronic Market, has had a high success rate in predicting presidential election outcomes, and the project's organizers believe the markets are a better prediction tool than polls.

"Pollsters are asking how would you vote in a fictitious election tomorrow, and we're asking how is everyone else going to vote in the election?" said Forrest Nelson, University of Iowa economic professor and one of the Iowa Electronic Market directors. "Polls aren't meant as predictive devices; they're meant to sample opinion. So you can't really replace polls."

Nelson and some colleagues began the markets in 1988 as a research project after they saw the results of the Michigan Democratic caucuses, which Jesse Jackson won, beating eventual nominee Michael Dukakis.

"We were talking about how the polls got it wrong. If the Chicago markets did as bad a job at predicting the price of corn, those markets wouldn't exist," Nelson noted. Along with the original goal of determining whether or not markets could predict election outcomes, the University of Iowa Business School now uses the markets as a teaching tool.

The Iowa markets allow traders to invest small amounts of money in candidates, and in 2004 had about 1,500 active traders participating, Nelson said. On Election Day that year the site received more than 1 million hits, he added.

But some experts argue that such markets are not better predictors of elections than polls. Columbia University political science professor Robert Erikson co-authored a paper this year arguing just that.

Opinion polls, especially early in an election season, tend to have inflated results, Erikson said.

"Let's say for example, in April of an election year, the early leads are going to be inflated. If you adjust for inflation, by that test the poll prediction beats the market," Erikson explained. He noted Bill Clinton's two presidential elections during which early polls gave him an easy win. The markets, however, gave him smaller odds, Erikson said.

Meanwhile, James Campbell, a political scientist at the State University of New York, Buffalo, said polling information influences market movement significantly. A dip in the polls, for example, might cause a candidate's price to drop.

"If you isolated the market participants from poll information, you probably wouldn't get as accurate forecasts from the market as you get today," Campbell argued.

Yet historical research shows otherwise.

Political stock markets going back at least to 1880 had a significant prediction success rate, according to Koleman Strumpf, a University of Kansas business economics professor who co-authored a paper examining the historic markets in 2003.

Even before the use of polls to track elections, the markets had widespread participation, Strumpf said.

"They didn't have polls back then, so this is basically what they did instead of polls," he said. "It's pretty amazing that these things worked. Put yourself back in the early 20th century. There's no television, there's no radio, there's barely functioning telegraphs at this point."

The historic New York markets correctly predicted 11 of the 13 presidential elections between 1884 and 1940, according to Strumpf's paper, "Historic Prediction Markets: Wagering on Presidential Elections." At the markets' height in 1916, participants invested $165 million in candidates (2002 dollars).

While the Iowa markets operate on small investments as a teaching tool, some other companies are trying to figure out how to transfer the growing popularity of sports betting to politics.

Several international companies allow users to purchase contracts based on who they believe will win gubernatorial, Senate and presidential elections.

As of Tuesday on Ireland-based Tradesports.com, more than 43,000 units wagering that U.S. Sen. Hillary Rodham Clinton would become the Democratic presidential nominee in 2008 had been traded. More than 300 units had been traded in the Maryland gubernatorial contest, with contracts for the Democratic nominee selling for $7.50 and contracts for the Republican nominee going for $1.50.

Walter Hill, the chairman of the St. Mary's College of Maryland Political Science Department, said he believes financial investment in the markets adds to their accuracy.

"I think the fact that there's some sort of monetary award matters," Hill remarked.

But Hinton, the operator of casualobserver.net, said he believes his market, despite its use of play money, fits into a growing trend of "do-it-yourself media."

As for the concern that a candidate's supporters can manipulate the markets, Hinton and others suggested such markets tend to correct themselves fairly quickly.

And even though Hinton's site will not allow traders to use real money, Iowa's Nelson said "funny money" markets tend to get the predictions right in the end.

"They bounce around a lot more. You get the same predictions from funny money and real money markets, but real money is more stable," Nelson explained.

Strumpf, the University of Kansas professor, said it seems the markets are here to stay, particularly with the Internet making them easier to access.

"When there's demand, supply will rise to meet it," Strumpf noted. "These markets aren't going to disappear anytime soon."

Copyright 2006 Dolan Media Newswires
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