Dangers of political betting markets

I’m a big fan of prediction markets, and I think that in most cases, they do good by creating more accurate estimates.  But for the positive outcome of allowing hedges and funding research, I wonder if there is a problem for markets on political races.

For example, wouldn’t large, liquid betting markets allow candidates to fund races more easily?  A candidate who wins can cash in by selling their political influence.  So rather than spending their own money, a moderately wealthy candidate might borrow $10M (using personal collateral, perhaps), and bet $5M against themselves on the markets.  They spend the other $5M on their race.  If they win the election, they lose the bet, and pay back the $10M with funds raised from special interests.  If they lose the election, they’ll win the bet, and pay back the loan with the proceeds.

Things are similar from the standpoint of a campaign contributor, attempting to buy political favors.  Many of them simply donate to both sides.  But another option is to hedge your donation by using some of it to bet against your favored candidate.  That way you guarantee either getting favors or winning some money.  Reducing the risk of investing in candidates should increase the amount spent.

So while being able to hedge risk is normally considered a good thing, in the coercive business of politics, it’s not so clear.  Isn’t it better for political favor to be expensive and risky to purchase?  Are there some markets that are better if inefficient, like the market for political favors?

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  • Compared to markets that predict who will win, the public interest case is much stronger for markets that give the consequences of electing any particular candidate. Alas, we have almost no political markets of this more valuable kind.

  • Douglas Knight

    Some people are in favor of markets in law. Public choice says that government will transfer money from diffuse interests to concentrated interests because of transaction costs, but prediction markets could lower those transaction costs. Small players who cannot hope to buy policies in the current system can hedge the value of the election using an election market.

    I don’t buy your examples, but I agree with the heuristic that offering more options to politicians is bad. On the other hand, offering more options to contributors might reduce contributions. It might draw a clearer line between money paid to get a politician elected and money paid to change a politician’s positions. But I’m not even sure if that’s a good thing.

  • Silas

    Actually, I came up with a similar idea recently: what if it were possible to pool assets and insure against every possible policy change that could hurt you? For example, if your job heavily depends on e.g. the Department of Defense having a large budget, you buy a policy that pays out in proportion to budget cuts for that department. Or, if you like a particular item, you can insure against it being banned (i.e. you get a large payout, which softens the blow). This would make it so that government is basically unable to manipulate behavior since any congressional proposal would merely shift insurance premiums slightly, and because congress members’ votes would be largely dictated by their own bets.

    Arguably, something similar has happened in financial markets: the proliferation of hedge instruments has significantly limited the influence of the Fed.

  • Dagon

    Isn’t this just a specific case of the more general problem that political decisions are supposed to be in a different realm than financial ones?

    For the simple cases, it seems likely that “interested parties” would be forbidden from participation in the betting. Politics is already pretty much a sporting event, so similar rules seem reasonable. But the more complicated cases are very hard to solve. There’s a LOT of private information and fast-breaking news to give opportunities to insiders.

    You didn’t make the connection between a betting market and the ability to buy and sell votes, but it’s not that far of a leap. It wouldn’t take long before everyone in a district receives in their mailbox an anonymous $20 wager receipt for a certain outcome of a race.

  • Chi

    But aren’t current prediction markets already implicitly markets about impact, in the same sense that EY’s catastrophe market reflects interest rates? People can choose to associate their own distribution of utility to the actual market’s outcome. People can rejoice that Google tanked 20% in a week, if the small pain of owning a couple hundred shares is deemed insignificant, and so could be rational to short their own investment. One way to avoid this is to lower the level of compensation, and make sure the Honor won by ending up right outweighs the money.

    In some sense aren’t bribes signals to those in power about the business impact of certain policies? What (if anything) does the economics of competition say about this?

  • Chi

    In the same sense: because people in the market might value a bet in their head for different reasons (a native sense of the interest rate) than the vocal purpose of the market (to predict the likelihood of an event in the next X years).

  • Congratulations, Silas, you’ve invented the political derivative, soon to be involved in a mind-bendingly complicated financial meltdown in a country near you.

  • Random thought: is promising to cut taxes the same as trying to buy votes?

  • The problem with this is that it only reinforces the existing advantage that goes to the richest candidate. As the candidate, your minions could plunk down wedges of cash on your ticket (presumably it would be rational for them to do so, as long as they’re backing you to win!), shortening the odds; now, media-driven “perception” of momentum is already damn important in “the money race” – what would it be like if the actual odds drove it?

    Whatever we need, more power to the hereditary rich is not it.

  • Ian

    What’s wrong with political candidates hedging? They have information about how likely they are to win, too. If the goal is to predict the winner, shouldn’t we let the candidates themselves participate?

    Presumably, a candidate who would bet against himself would do so according to his perceived odds of losing. Otherwise, how would he come out with even money, win or lose? He can’t count on the current odds, since they could change; he’s got to put his money where his mouth is like everyone else in the betting market and use his own information to formulate a bet. The premise of this post of borrowing $10 and using half to bet and half on the campaign is simplistic – the amount to allocate to each should be proportional to the odds of winning, not the nominal amount at stake.

    And, if other betters think that the candidate’s bet was inaccurately, there’s a golden opportunity for them – betting the other way just got cheaper!

    A few people mentioned that politicians might try to manipulate the markets, but Slate has an article that describes how someone may have attempted this during the Bush/Kerry 2004 election http://www.slate.com/id/2169647/). Just like betting markets are supposed to work, the market seized on the opportunity:

    “But it’s hard to manipulate markets for long. In the 2004 case, Bush’s re-election probability climbed back to 54 percent within minutes as profit-seeking traders spotted the free money. “When I heard about it, I started checking the betting markets in the early hours a lot more closely,” says Justin Wolfers.”

  • This isn’t a danger of prediction markets: it’s an example of how prediction markets illustrate problems with existing institutions.

    How is this any different from Lieberman running for the Senate in 2000? He was hedging his bets inefficiently; why not let him be open (and cheap) about it next time?

  • Random Visitor

    “He can’t count on the current odds, since they could change; he’s got to put his money where his mouth is like everyone else in the betting market and use his own information to formulate a bet. The premise of this post of borrowing $10 and using half to bet and half on the campaign is simplistic – the amount to allocate to each should be proportional to the odds of winning, not the nominal amount at stake.”

    Actually, current odds don’t matter at all if the outcome is a binary one like be president or not. Using the underlying of a simple derivative (with a binary outcome, which we obviously have here) and a riskless asset you can always hedge away all risk trivially.

    A numerical example has already been given in the original post, so I refrain from constructing one here.

    See Cox-Ross-Rubinstein’s binomial tree for option pricing, but the principle can be used in a wider context. (I won’t go into the convoluted thing that is the riskless probability here).

  • Ian

    I don’t fully understand the binomial options pricing model, Random Visitor, but I gather that it is an expected value calculation at its heart.

    I’m not sure, though, if an expected value of the derivative would satisfy the politician. After all, he would want to conclude his campaign, win or lose, with the same amount of money (or utility). If he’s not going to execute similar campaigns (or take similar risks, with similar odds) a large number of times throughout his life, expected values don’t remove the risk at all. To drive this point home, suppose someone offered you a one-time bet on a coin toss for $1 million – would you take it? Probably not, even though your expected outcome is $0. If the person promised to offer the bet to you 1,000 times, you’d be indifferent, but a one time bet is just too risky.

    Also, I’m not sure politicians could hedge very easily. A politician could place his bet mere minutes before the election so that he is certain of the odds (and, hence, how much to bet), but then he wouldn’t have access to this money to spend on the campaign.

    Alternatively, the candidate could bet several months before the close of the market, but the odds could change a lot. He can assign his own personal probability to winning, but it’s unlikely to be as accurate as the market (that’s the whole idea of betting markets, right? The many are smarter than the few?).


  • If the increased ability of candidates to finance their election is a problem (I can’t predict whether it is), it seems likely that disclosure rules could deal with it. Voters would tend to be suspicious of candidates who make large bets against themselves, and traders would be reluctant to trade against such a hedger. To be enforceable the disclosure rules might need to have the exchanges identify and publicize the candidate’s orders.
    It’s hard to see how donors’ behavior would be affected by hedging opportunities. Do donors ever invest a large enough fraction of their wealth in candidates that risk aversion would make a rational donor care about hedging? Or would any biases which cause people to act irrationally risk averse apply to campaign donors? As far as I can tell, the answers are no. The inefficiencies associated with collecting on illegal investments seem to prevent such large investments and to discourage biases such as endowment effects which cause irrational desires for hedging.

  • Stuart Armstrong

    You’re assuming a candidate wants to win. But what would happen if a successful candidate decides he wanted to cash in rather than win his election? For a candidate to lose his election is very easy – the odd racist or pro-pedophile comment “accidentally” slipped into a speech.

    If the betting markets allow bets on percentage of the vote, not only on result, then even losing candidates may be more tempted to destroy their campaign for cash.

    This could hugely undermine the effectiveness of betting markets, even with disclosure and insider trading sorted. A candidate bet against himself may be a hedge, a preparation for the self-imollation of his campaign, an attempt at publicity, or maybe a superstitious gesture. Each carries very different meanings, and interpreting them depends on knowing the inner mentality of the candidate, something that is practically impossible. This would dilute the reliability of the betting market, especially if the bet is large.

  • You’re assuming a candidate wants to win. But what would happen if a successful candidate decides he wanted to cash in rather than win his election? For a candidate to lose his election is very easy – the odd racist or pro-pedophile comment “accidentally” slipped into a speech.

    That’s a very good point. Consider the history of sports betting. Now imagine if it were okay for a professional sports player to bet against himself. It’s easy to throw a game, or just not score enough points to beat the spread.

    Second, markets are subject to their own irrationalities; just consider the various stock market bubbles that sometimes occur. For that matter, why was there EVER a market for Beanie Babies as high-priced collectibles? When the “greater fool theory” becomes the primary justification for buying something, and there really are plenty of greater fools around, then individually rational behavior can become collectively ridiculous.