Market Makers
Can Intrade Win After The Election?
Joshua Zumbrun 11.03.08, 2:00 PM ET

Washington, D.C. -

Polls this weekend showed tightening in the presidential race. But in political futures markets--where people put their money where their votes are--John McCain is toast. As of Monday morning, traders at the popular Intrade market gave him a 10% chance of winning the election; Democratic candidate Barack Obama, 90%.

Are they right? Intrade CEO John Delaney sure hopes so. So far this election cycle, trading volume on McCain and Obama contracts has topped 1 million each, and the final days of the election are among the busiest. According to Intrade, there are 548,227 shares outstanding for Obama and 576,895 for McCain. That means come Election Day, the contracts will close out for $5.48 or $5.77 million.

And that's just on who wins overall. Intrade also has markets on the outcome of the election in every state. On Monday, traders bet on Obama to win in states with 364 electoral votes, McCain in states with 174. Over the weekend, Missouri's 11 votes have vacillated back and forth between the candidates. Traders think this is the toughest race to call. The volume is approaching 200,000 trades on contracts for states.

"Our political market trading volumes have increased 380% election cycle-on-cycle already, and the next few days will be our heaviest yet," says an Intrade spokesman.

In all, Justin Wolfers, a professor at University of Pennsylvania's Wharton School of Business who studies prediction markets, estimates that $50 million to $100 million may have been bet on this election at sites like Intrade. Not bad. But to make a real business of it, they'll need something more: clarity from the U.S. government. Right now, political futures markets where money changes hands are in legal limbo in the U.S.

That's why Intrade hopes the Commodity Futures Trading Commission will take up its petition for oversight. Over the summer the CFTC held a request for comment on events markets. The matter is currently "under staff review," according to a CFTC official. This legal limbo holds the key to unleashing liquidity on Intrade.

"Less than full legal transparency for our members does impact their confidence and therefore the liquidity in certain markets," says Intrade's Delaney. "There is no doubt that the CFTC will provide additional clarity in the future, and we believe that this additional clarity will enable our marketplace to offer the maximum trading and informational benefits to all possible," Delaney says.

A privately-owned Irish company, Intrade makes money off a five-cent commission on trades. That would mean the company has presumably earned just $120,000 off the 2.4 million trades of McCain and Obama contracts--chump change. But what if it were clearly legal? The floodgates would open, Intrade says. They predict that if the CFTC clarified their legal status, the volume traded would increase more than 20-fold in the first year.

A clarification from the CFTC would likely effect more than just Intrade. Wharton's Wolfers says that even major exchanges would likely be interested in offering contracts on the elections. "Investment houses already take bets on elections, but they do it through their portfolios," says Wolfers. This would be more direct.

The flood of liquidity might also diminish the possibility of manipulating the markets, a concern among some critics of political futures. Currently, dropping large sums of money on the market at odd hours of the night can sharply increase prices. This could theoretically be done to trick journalists into running with stories that momentum has changed. With markets of current size, that could be done with mere thousands of dollars. But if markets explode in size, such manipulation would quickly become prohibitively expensive.

So how wise are these crowds? Freakishly so in 2004, correctly predicting the winner in all 50 states. But markets sometimes get it wrong--the market itself says there's a 10% chance of that. As recently as the Democratic presidential primary in New Hampshire, the markets completely blew it by projecting a 92% chance that Obama would beat Hillary Clinton, after his win in Iowa. (Defenders of the market will point out that you'd expect to see a 1-in-15 market event roughly every 15 events.)

Still, Robin Hanson, an economics professor at George Mason University who has studied prediction markets, hopes they grow. "Stock markets, insurance markets, commodity markets--they used to be prohibited by gambling laws but were thought to be useful and given an exception," says Hanson. "We want to carve out a new set of exceptions. This topic is valuable to know about. There's a social benefit to knowing about it." And money to be made, too.