Can Election Futures Markets be More Accurate than Polls?
The students examine results from opinion polls conducted near the end of the 2012 presidential campaign. They compare results from several national polls to those of the Iowa Electronic Markets (hereafter, the IEM), an online futures market, to predict the outcome of the 2012 race. They read and discuss a handout which allows them to compare the performance of opinion polls and the IEM in predicting election outcomes. Finally, the students learn how well the IEM performed in the presidential campaign of 2012.
Public opinion polls are an important part of American political life. Polling informs and influences political debate, the state of the economy, social trends, and more. Political scientists and polling companies have developed sophisticated techniques to make polling more accurate. Now, however, there is another approach to predicting election outcomes, and it may prove to be even more accurate than polling. This approach uses futures markets in which people risk some of their own money to predict the outcome of such things as presidential elections.
POLITICAL CONCEPTS: Public opinion polls
This lesson was originally published in CEE's Focus: Understanding Economics in Civics and Government. Visit CEE's store for more information on this publication and how to purchase it.
- Explain how public opinion polls and futures markets are used to predict election outcomes.
Compare and contrast the market-based approach to the polling approach for predicting outcomes of presidential elections.
Set the stage by explaining that U.S. presidential elections are tremendously important to Americans and to others throughout the world. Because the elections are so important, many people work hard to try to predict their outcomes.
Tell the class that the purpose of this lesson is to compare two approaches for predicting the outcomes of presidential elections. The first is to use the traditional and highly sophisticated opinion polls conducted by such well-known organizations as Gallup and Harris. The second is to use the Iowa Electronic Markets (IEM), an online futures market where contract payoffs are linked to election outcomes. Ask the students: Can a relatively simple market-based system outperform sophisticated opinion polls? (Accept any answer for now.)
Display Slide 1, which summarizes 9 predictions made about the 2012 presidential race. Ask the students to compare the predictions of the nine national polls to the prediction of the IEM. (The IEM outperformed six the nine national polls. Only 5 of the 9 polls polls predicted President Obama as the winner. Three of the national polls were closer to the ultimate margin of victory than the IEM. The IEM performed very well without identifying a random sample of likely voters or making one telephone call.
Distribute Activity 1. Introduce it as a source of information about the two approaches to predicting election outcomes. Ask the students to read it. After they have completed the reading, ask:
What are two challenges that polling companies face in their efforts to get accurate results?
(Pollsters face many challenges. They must carefully identify random samples of people who best represent the opinions of the relevant population. They must make telephone calls at times when the people they want to talk to are likely to be at home. They must develop unbiased questions. And sometimes they must deal with evasion and dishonesty; the people they reach might not be truthful in their replies.)
How does the IEM work to predict the outcomes of presidential elections?
(The IEM enables individuals to buy and sell contracts reflecting their predictions. For example, the IEM operates a “winner-takes-all” market where contracts for the presidential candidate with the largest share of the popular vote pay one dollar [$1], while contracts for the losing candidate pay nothing. Each contract therefore has a maximum value of $1, and trading accounts can be opened for $5 to $500. )
What is a futures market (such as the futures markets overseen by the CME Group)? How is a futures market like the IEM?
(The CME Group is an entity formed by the merger of the Chicago Board of Trade [CBOT] and the Chicago Mercantile Exchange [CME]. It is a futures exchange where people buy and sell contracts for the future delivery of commodities and various financial instruments: corn, wheat, and soy beans as well as stock indexes, interest rates, and foreign exchange. The IEM provides a political futures market where people speculate on future election results, using relatively small amounts of money.)
Why might the IEM produce better results than traditional opinion polls?
(The IEM has two big advantages over traditional polls. First, people who buy candidate contracts through the IEM put their own money at risk. Buyers who put their money at risk have an incentive to be careful—to search for relevant information and try to make the right choice. Second, people who buy contracts through the IEM participate voluntarily. They have no incentive for misrepresenting their views.)
- What are two challenges that polling companies face in their efforts to get accurate results?
Display Slide 2. Review the final results of the 2012 presidential race. The IEM market appears again to have predicted the final outcome better than traditional polls.
Display Slide 3. Note to the students that the IEM had shown Barack Obama with a consistent lead throughout the last nine months of the election cycle, from the primaries to the general election.
Display Slide 4. Point out to the students that the markets react quickly to candidate comments.
- If you wish to extend the lesson, go to the IEM website at http://tippie.uiowa.edu/iem/ and examine the races that are currently being followed at the site.
In closing, review the lesson by posing the following questions:
What are some of the challenges facing the firms that conduct national polls?
(Pollsters must carefully identify random samples likely to represent the opinions of the relevant population, make telephone calls at times when the people they want to talk to may be home, and develop unbiased questions. Sometimes they must deal with interviewees who are not truthful in their replies.)
What is the IEM?
(The IEM is a set of real-money futures markets where contracts on the outcomes of political and economic events are traded. The IEM allows individuals to buy and sell contracts reflecting their predictions. For example, the IEM operates a “winner-takes-all” market where contracts for the presidential candidates are bought and sold.)
What are the advantages of the IEM over traditional polling?
(Unlike traditional opinion polls, the IEM does not work with randomly selected groups of people. It depends on informed individuals who have an incentive to make an accurate prediction: They can make money if they purchase the contract of the winning candidate. In the IEM, there are no problems of sampling, posing unbiased questions, or calling people at the wrong time of day. The IEM does none of these things. The individuals who buy contracts using the IEM also have no incentive to misrepresent their views.)
What happens to the value of a presidential candidate’s futures contract when the candidate experiences favorable news about the likelihood of winning the election?
(Favorable news about the likelihood of success for a presidential candidate will increase demand for the contract and will therefore increase the contract price. In this way, the IEM market is similar to other markets in which prices are determined by forces of supply and demand.)
Extension Activity not available.
Which of the following are challenges facing firms that conduct opinion polls?
- Identifying non-random samples, interviewing a sufficient number of people, asking unbiased questions, reaching the correct people in an unbiased way.
- Identifying random samples, interviewing a sufficient number of people, asking unbiased questions, reaching the correct people in an unbiased way.
- Identifying random samples, conducting a sufficiently large number of interviews in shopping malls, asking biased questions, reaching the correct people in an unbiased way.
- Identifying random samples, finding the right number of interviewees in the telephone book, asking biased questions, reaching the correct people in an unbiased way.
Which approach is used by the IEM to predict the outcomes of presidential elections?
- The IEM is well known for the Nelson, Neumann, and Forsythe (NNF) poll, which operates much like the Gallup and Harris polls.
- The IEM allows traders to use an open auction of presidential candidate contracts who meet face-to-face in trading pits.
- The IEM allows individuals to buy and sell candidate contracts online, reflecting their predictions about presidential races.
- The IEM is well known for its regression analysis that has successfully predicted the outcomes of several presidential races.
Compare traditional opinion polling to the IEM, noting advantages and disadvantages of each. In your discussion of the two methods, make use of information from the 2012 presidential election.
(Traditional opinion polls have several advantages. They use carefully designed methodologies that often [not always] produce accurate predictions. For example, five out of nine polls in Slide 1 predicted the correct outcome in the 2012 presidential race. But polling also has many disadvantages. It is difficult to identify random samples, make telephone calls at the right times, and develop unbiased questions. Moreover, people reached by pollsters might not be completely truthful in their replies.
The IEM has several advantages. Because it is not a poll, it avoids all the problems associated with conducting polls. In addition, the IEM provides an incentive for anonymous individuals to search for information on their own and choose the best candidate. In 2012, the IEM outperformed six of the nine national polls. Markets like the IEM, if allowed to charge fees, could easily pay for themselves and thus be far more efficient than traditional polling. A disadvantage of the IEM might be that some people are skeptical of unregulated markets.)
The IEM is gaining a reputation for forecasting election results with great accuracy. Can you imagine other uses for this approach?
(The IEM approach can be used to make predictions in a variety of cases for which there will ultimately be a clearly defined answer. For example, the IEM offered a futures contract on Federal Reserve monetary policy, in which the future value of a federal funds rate futures contract is traded. The IEM has also experimented with contracts predicting the value of economic announcements, the reported quarterly profits of publicly traded firms, and even box-office earnings from newly released motion pictures. There are many policy variables to which this approach could be applied.)