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Romney loss cost trader up to $7 million: Study

Mitt Romney
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Mitt Romney may have taken the fall in the 2012 presidential election, but the trader who bet as much as $7 million on the Republican nominee was the one who took the hit.

An unidentified fan of the former Massachusetts governor flooded former online wagering site InTrade in the weeks before the election, wagering heavily that President Barack Obama was about to go down to defeat, according to an academic study released this month.

The consequences were twofold—an enormous loss for the wrong-way bettor, and an example of how such sites can be manipulated by one person with a clever betting strategy.

David M. Rothschild of Microsoft Research in New York and Rajiv Sethi at Barnard College believe the trader in question was using a strategy that not only sought personal gain but also looked to raise spirits.

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Much of the wagering, they said, was done on Election Day "and at other critical moments of the campaign."

More plausibly, this trader could have been attempting to manipulate beliefs about the odds of victory in an attempt to boost fundraising, campaign morale, and turnout.

In all, the paper looked at a 15-day period during which 3.5 million contracts were traded between 3,200 accounts on Intrade—which has since been disbanded under regulatory pressure—and Betfair.

The sites were popular places for bettors to play the election, and the trends reflecting the probable results were cited frequently by the media:

The single largest trader was responsible for more than one-sixth of (double-counted) total volume, with more than 1.2 million contracts bought or sold in about 13,000 distinct transactions. The most frequent trader engaged in almost 34,000 transactions, accounting for more than 20 percent of (double-counted) total observations. The largest 32 traders (just 1 percent of the trading population) were responsible for 60 percent of volume, while the 32 most frequent traders accounted for 57 of transactions.

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One of those traders clearly went all-in for Romney.

Trader A was responsible for one-third of the total money on Romney over the two weeks in our sample, and about a quarter over the entire cycle. The result was a loss of close to four million dollars over the two week period, and a likely loss of almost seven million overall. What could possibly have motivated this activity? Given that the trader bet on Romney and not Obama, we can rule out cross-market arbitrage with Betfair as a motivation.

This leaves three possibilities: (i) the trader was convinced that Romney was underpriced throughout the period and was expressing a price view, (ii) he was hedging an exposure held elsewhere, or (iii) he was attempting to distort prices in the market for some purpose.

Ultimately, the analysis "leaves open the possibility" that the trade was simply about "market manipulation for political purposes" and whoever lost the money really didn't care.

The trading losses, while hardly trivial, pale in comparison with the cost of contemporary political campaigns. Beliefs about the likelihood of victory are important determinants of fundraising as well as volunteer effort and morale.

Some voters appear to have a preference for affiliation with a winning candidate, and are prepared to abandon those seen as likely to lose. Turnout can also be affected by perceived candidate viability. Intrade was among the most closely watched indicators of campaign vitality, resulting in incentives for price manipulation to boost support, donations, effort and morale prior to the election and turnout while voting was in progress. The last swing state to close its polls was Colorado at 9pm ET (7 pm local time), and this is almost exactly when the floor in the Romney contract gave way.

The paper found the manipulation of the market successful at least to a point, with the trading strategy remaining intact even if Obama still won the election.

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Similar strategies, Rothschild and Sethi said, could find their way into the stock market.

Such dynamics are most likely to arise in electoral prediction markets and in sports betting, but similar effects may well exist also for common stock. Especially in the case of consumer durables, attachment to products and the companies that make them is widespread. It would not be surprising if one were to find Apple or Samsung partisans among investors, just as one finds them among consumers.

—By CNBC's Jeff Cox. Follow him @JeffCoxCNBCcom on Twitter.