Friday, January 4, 2008

In the wake of the Iowa primaries, some political entries

1. The Myth of the Rational Voter:
Bryan Caplan's article today in the Washington Post 5 Myths About How Americans Vote. Andrew Gelman's comments are here and here. The implication of voter irrationality is that the country should be ruled by elites "who know better than the masses". This sounds like the type of system that was in place pre-Andrew Jackson (at least from my reading of HW Brands' biography of Andrew Jackson). John Adams' and the New England ruling elite were in favor of keeping the status quo rather than extending democracy to the masses.

2. Is voting irrational? Yes according to economists, but no according to Andrew Gelman here. My reading of his post is that there are large expected gains if the candidate you favor wins (a little bit like why people buy lotteries?)

3. How well did prediction markets predict the Iowa primary?
From Justin Wolfers' article in WSJ or here (pdf):
On the Democratic side, Iowa is expected to be a virtual three-way tie. On New Year's Eve, markets ranked each of Barack Obama, Hillary Clinton and John Edwards at least a 30% chance of winning.
The results from New York Times:
Barack Obama 37.6% John Edwards 29.7% Hillary Clinton 29.5%

Here is Marginal Revolution's take on the primaries based on the effect of the primary on the Winner Take All Market on the Iowa Electronic Markets - no effect at all, hence the title of the post, The Candidate Doesn't Matter. (I think it remains to be seen.) Here is Andrew Gelman's opinion on prediction markets.

Update: Justin Wolfers, Andrew Gelman and Bob Erikson debtate prediction markets versus polls on Gelman's blog entry. My question: How well would prediction markets have performed in the absence of polls? Of course, this is hypothetical, but I think they would not function as well. So the next item ...

4. So based on prediction markets for election results, what about those terrorism futures? I'm a little skeptical how well these would work. Studies indicate that market "thickness" and liquidity is important for a market to be an unbiased predictor. The markets for these terrorism futures are likely to be thin. Economists have to be able to answer the questions:
a) What determines market liquidity and thickness? As in Andrew Gelman's post, I think that news (a lot of news) is important.
b) Models/forecasts function as polls and hence as generators of news. How many producers of such models are there and are there enough consumers of these models?

In light of the response to Bob Shiller's macro markets as blogged by Mankiw:
Other products also continue to experience trading issues, like the MacroShares oil shares that encountered trouble last year. The products were developed by Yale economist Robert Shiller to track crude-oil futures prices but have continued to trade at a wide "spread," or difference, from their underlying shares. The firm conducted a 3-for-1 stock split to try to reduce the products' share price and encourage buying.

MacroShares has also split from its partnership with Claymore Securities, dropping the Claymore name. In November, the MacroShares Oil Down product was trading at as much as an 80% premium to its net asset value, which ETF prices generally closely match, while the MacroShares Oil Up product traded at a 20% discount.

"Kill These ETFs, now" wrote Greg Newton on markets Web site Naked Shorts at the time.

"The MacroShares are irretrievably broken" and "a disgrace to the ETF market."

"I think there's been some misconception about the pricing of the securities," says Mr. Shiller. He has been talking to government officials in Dubai and Norway about how the MacroShares could be appealing for hedging oil bets in their investment funds. "I've tried to get the message across, but it's been hard."

I am skeptical. I equate Shiller's securities as the same kind of securities that would trade in a prediction market.

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