Event futures trading tests the “wisdom of the crowd” theory
Trump's election to U.S. President caught many people by surprise. But not the users of PredictIt, an event futures market run by a political consulting firm in Washington, D.C. The pricing of its futures contract on the election correctly predicted the result well ahead of the polls.
PredictIt works by allowing people to buy and sell binary options on a range of political events. The price rises and falls in line with the expectations expressed by people through their trades and serves as a forecast of the outcome. This attracts people who have strong views on politics and are willing to back those views with real money.
According to the company's demographic data, its traders tend to be affluent (with an annual income of $100,000-$200,000) and well-educated millennials (aged 22-35) who live in main metropolitan areas of the U.S. Most of them work in finance, law, politics and technical fields such as mathematics, statistics and economics. Over 150,000 accounts have been opened on the site since it launched in 2014, with around 80,000 active users at any given time.
Trading volume averages 1.2 to 1.5 million contracts per day. That jumped to 13.7 million on one of PredictIt’s busiest trading days to date, the U.S. election day on Nov. 8, 2016. In contrast to many other polls, the PredictIt market began to lean towards a Trump win hours before the election was officially called.
The success of PredictIt is a real-life demonstration of an economic theory that futures markets are more effective at predicting future outcomes than public polls or expert opinion. The idea is that markets tap the “wisdom of the crowd” by aggregating information from a wide range of people.
U.S. futures laws do not allow citizens to gamble on political outcomes, but the Commodity Futures Trading Commission is willing to grant an exemption that allows a company to operate a prediction market so long as it remains small scale and supports academic research. The best known example is Iowa Electronic Markets, a futures market run since 1998 by the University of Iowa's business school. In PredictIt's case, the prediction market is sponsored by the Victoria University of Wellington in New Zealand, which received an exemption from the CFTC in 2014. The operational side of the market is run by Aristotle, a Washington-based company that provides technology for political campaigns.
The CFTC’s exemption mandates that PredictIt cannot allow more than 5,000 traders to take part in any given market and that no one can bet more than $850 in any given contract. According to a spokesman for the company, as few as 15 to 40 people in a prediction market can create a more than accurate forecast, so these limits are not really a concern. PredictIt also has 125 academic partners from universities across the world who use its anonymized data, which it offers free of charge.
Outside the U.S., the restrictions on scale and academic purpose do not exist and a number of sports betting companies run much larger prediction markets. One of the largest is Ireland-based Betfair, which claims to cover the most liquid markets on political events. As such, it provides the best reference point for the likelihood of political outcomes, according to Katie Baylis, the company's media relations manager. “Due to it being a betting exchange, rather than a traditional bookmaker, you can typically get better prices on liquid exchange markets than you would from the bookmakers, which is an appealing proposition for people looking to bet on politics,” Baylis said.
Larger events, specifically the major elections, are very popular and attract signicant amounts of money on Betfair. In 2016, the year of the Brexit vote and the U.S. election, politics was the seventh biggest ‘sport’ on the exchange in terms of volume traded. Since the start of 2016 there has been over £3.4 million in matched bets from £550 million traded on political events on the site. Over £400 million was wagered in 2016 on Brexit and the U.S. election. Currently, the biggest live markets are the markets that are based on Trump’s future, even though Betfair has restrictions in place that prevent U.S. citizens from registering with the site. In fact, trading has already started on the outcome of the 2020 U.S. Presidential elections, with big moves on several celebrities such as Oprah, the Rock and Mark Zuckerberg.
Attempts to bring these markets into the U.S. have run into legal problems. In 2012, the CFTC brought charges against Intrade, an Ireland-based prediction market, for allowing U.S. citizens to trade its contracts. In the same year, the North American Derivatives Exchange, a binary options exchange formerly known as HedgeStreet, was prohibited from launching political events contracts, as the CFTC determined that the contracts “involve gaming and are contrary to the public interest.”
That leaves U.S. citizens facing a limited range of options, with PredictIt an increasingly popular choice. PredictIt's markets do not always make accurate predictions. For example, it failed to forecast the leave vote outcome in the Brexit referendum. But its markets tend to get to the right answer sooner than other traditional forecasting methods. In an age of political uncertainty, a bet on their growing popularity would be a fairly safe one.
