There is a professional poker player in Queens named Serge Ravitch who is convinced that he can make money off this year’s presidential election. But to explain what he’s up to, I want to start with a story about last week’s Democratic primary in California.
By early evening last Tuesday, the day of the primary, Hillary Clinton looked very likely to win California. The initial exit polls, which were released to the media around 5 p.m. Eastern time and posted on various blogs by 7 p.m., showed Mrs. Clinton ahead by three points. As subsequent polls came out, her lead grew.
But everyone knows that exit polls can be misleading. (If early exit polls were always right, President John Kerry would now be running for re-election.) So on Tuesday evening, I also checked out Intrade, a Web site where people buy and sell contracts whose price is tied to real-world events. Strangely enough, the prices on Intrade were suggesting that Barack Obama would win California.
There was good reason to take those odds seriously: Intrade has done an excellent job of predicting election results over the last few years. In 2004, President Bush won every state in which Intrade’s contracts — as of the night before Election Day — gave him a better than 50 percent chance of winning. He lost every state where the traders thought Mr. Kerry was the favorite. Late on election night in 2006, while the talking heads on CNN and MSNBC were still saying that the Republicans would hold onto the Senate, Intrade knew better.
It’s no wonder, then, that the site has become a phenomenon. In recent months, when I have asked former advisers to Mr. Bush or Bill Clinton what they think will happen in 2008, they’ve often talked about Intrade. The Wall Street Journal and The Financial Times run regular online features based on the odds. Journalists — me included — have praised Intrade as a miniature version of the stock market, where the collective wisdom of the masses reveals a larger truth.
But now a little backlash has begun. Barry Ritholtz, author of the popular Big Picture economics blog, has put together a list of Intrade’s misses. Last Tuesday, meanwhile, I e-mailed a high-profile Democratic economist and asked what he made of the dueling numbers coming from the California polls and from Intrade. He replied with a salty message, dismissing the usefulness of Intrade. Then there is Mr. Ravitch, a 27-year-old lawyer turned poker player whose previous claim to fame was his role in exposing an online-poker cheating scandal. In late December, he started posting notes on an Internet message board vowing to profit from what he saw as Intrade’s blatant inefficiencies. He has generally been announcing his trades as he makes them, and most of them have paid off. In the span of just six weeks, he says, he has earned a 35 percent return.
“I believe quite simply that the people who are trading on Intrade and the methods they’re using are so flawed that they can’t be right in the long run,” he told me.
After what happened in the California primary — Mrs. Clinton won there handily — I started to wonder if he had a point.
The mechanics of Intrade are simple enough. You can buy or sell a contract tied to the outcome of an event — Will Barack Obama win the California primary? Will “Atonement” win Best Picture? Will the United States or Israel bomb Iran this year? — so long as you can find someone else willing to be on the opposite side of the bet. Once the outcome becomes clear, the contract pays either $10 or nothing at all.
At 8:30 p.m. last Tuesday, the Obama-wins-California contract was selling for about $6 (which meant the market collectively thought he had a 60 percent chance of winning). If I wanted to bet on him and you agreed to bet against him, I would have deposited $6 in your Intrade account. Had he won, you would have owed me $10 — the original $6, plus $4 in profit. Since he didn’t win, you would have kept my money. It’s all very similar to the futures market on Wall Street.
Or at least it’s similar in concept.
In practice, Intrade is different because there still isn’t all that much trading on the site. (For legal reasons, Americans often have to use bank transfers, instead of credit cards, on the site.) John Delaney, Intrade’s chief executive, said that roughly $50 million in contracts tied to the 2008 election had changed hands already, which is up from $15 million for the entire 2004 election cycle. But $50 million is still roughly equal to the value of ExxonMobil shares that change hands every 10 minutes.
The limited size of Intrade’s market has created two main problems. The first is that the biases of a small group of traders can have a big effect on prices. And these biases seem most obvious in exaggerated odds for unlikely events. As Justin Wolfers, a University of Pennsylvania economist who studies prediction markets, notes, the odds “hit 5 or 10 all the time when a guy is dead in the water.”
Mr. Ravitch has made a nice profit betting against Ron Paul, the libertarian who late last year was, amazingly, given almost a 10 percent chance of becoming the Republican nominee. “If you asked anyone in politics whether there was ever, at any point, a 10 percent chance of Ron Paul being the nominee,” Mr. Ravitch said, without finishing the sentence. “That sort of makes my case for me.”
In a more liquid market, Mr. Paul’s small band of intense supporters wouldn’t be able to affect his price. On Intrade, they can. Along similar lines, Al Gore is now given an 11 percent chance of being the Democratic vice-presidential nominee, which Mr. Ravitch considers silly.
The second problem is that the market seems to react to new information too slowly. In a healthier market, you can’t easily predict where prices are going. After the drug maker Schering-Plough reported strong earnings on Tuesday, for example, its stock price jumped. But the stock is unlikely to continue soaring in coming weeks. The market has already adjusted to the news.
On Intrade, such reactions often happen in slow motion — and eventually turn into overreactions. Mr. Obama’s stock rose for days after he won Iowa, then fell during the two weeks after he lost New Hampshire and rose again in the 10 days after he won South Carolina. The impact of each contest took surprisingly long to sink in.
For this reason, Mr. Ravitch has recently been betting that the odds of Mr. Obama’s getting the Democratic nomination will keep going up this month, even though they were already around 60 percent when we spoke late last week. As Mr. Obama wins more primaries, Mr. Ravitch figures the contracts will continue to gain value, and he can then sell them before the March primaries, which look more favorable to Mrs. Clinton.
I suspect that something similar happened with the California contracts: There simply wasn’t enough trading volume to ensure that the market reacted quickly enough to new information. There wasn’t enough smart money.
The California prices were particularly striking, because in the past Intrade had been most useful on the day of elections. Its longer-term odds — like the fact that the Democrats are given a 66 percent chance of winning the White House — may be interesting, but they are based on probabilities that are inherently unknowable. On Election Day, by contrast, the odds can reflect real information, like exit polls, voter turnout and early returns.
So it’s certainly fair to say that Intrade isn’t as advanced as some of us had thought. But that’s why the existence of people like Mr. Ravitch is so welcome. As more traders try to exploit Intrade’s inefficiencies, those inefficiencies will become rarer and rarer.
Already, academic studies have shown that Intrade’s record is better than that of any single poll or any single pundit. Come Tuesday — when voters in Wisconsin and Hawaii go to the polls — I’ll be back at Intrade to try to figure out what’s going on. If you have any better ideas of where to look, let me know.