"Economic Choices '08"-Iowa Electronic Markets
Tuesday, November 06, 2007SUSIE GHARIB: In political markets, Hillary Clinton contracts are up 72 percent over the last six months, while republican front-runner Rudy Giuliani is up 36 percent and we are not making that up. As we continue our series "Economic Choices '08" Darren Gersh introduces us to the Iowa Electronic Markets, where trading in political candidates is a closely watched indicator of who's winning the race to the White House.
DARREN GERSH, NIGHTLY BUSINESS REPORT CORRESPONDENT: After watching many a presidential caucus, professors at the University of Iowa's Tippie college of business set up a kind of case study, asking what's the most accurate way to predict who will win a presidential election? Professor Joyce Berg says the solution was to replace public opinion polls with prices.
JOYCE BERG, PROF., TIPPIE COLLEGE OF BUSINESS, UNIVERSITY OF IOWA: And we're a business school, so we naturally turn to markets as a way to collect information and disseminate information.
GERSH: The result was the Iowa Electronic Markets, IEM for short. It works just like these guys, except the contracts being bought and sold aren't for pork bellies or corn. They're futures contracts on Hillary Clinton, Rudy Giuliani and the rest of the presidential field. Three times out of four, this market is more accurate than the polls, Berg says, because people pay more attention when there's real money at stake. The IEM also reacts immediately to news and is not a random survey; it's a market for insiders and political junkies.
BERG: In our markets, people who have thought hard are coming in the markets, so there is more information going into our market price.
GERSH: IEM traders can speculate on the outcome of next November's elections. But right now the action is in buying or selling contracts on each candidate running for his or her party nomination. Because a winning contract pays a dollar and losers get zero, the current price reflects the market's view of the odds a candidate will sweep the convention.
BERG: So right now for instance, if you were interested in Giuliani, you could buy Giuliani from another trader for $0.37.5. So if you thought he was definitely it, that would be a very attractive price for you and you'd want to buy.
GERSH: So right now, what the markets are telling you is that there is a 37 percent chance here that Giuliani will be the Republican nominee and Romney has a 33 percent chance.
BERG: That's exactly right.
GERSH: So this is different than the polls. This is much closer than the polls would show you. At $0.74, the market considers Clinton a better than 70 percent lock for the Democratic nomination. But Berg says that is not the same thing as predicting a Clinton victory.
BERG: It also means there's a 30 percent chance that Clinton won't be the nominee. That's pretty high -- a 30 percent chance that something else will happen. So if the weatherman says 30 percent chance of rain, lots of people are carrying umbrellas.
GERSH: Thousands of traders from around the world take part in the IEM online, but individual accounts are limited to $500. This is primarily a teaching tool. University of Iowa senior Michelle Collins says the IEM gave her a feel for what it takes to trade.
MICHELLE COLLINS, BUSINESS STUDENT, UNIVERSITY OF IOWA: When I wasn't paying attention to it, that's when I did lose a little bit. I learned a very inexpensive lesson to pay attention to it. I got caught up in final exams.
GERSH: Collins also learned not to let sentiment get in her way. You sold Obama, you're out of Obama. No chance.
COLLINS: Sorry, I actually like him.
GERSH: You like him, but no chance. This is money right?
COLLINS: Yeah, I want my dollar back.
GERSH: Berg says some Wall Street analysts use prices in the IEM to figure out how the election might affect portfolios.
BERG: These firms will use our market prices as really a point prediction of what is going to happen.
GERSH: MBA student Chuck Mersch is part of a group of students that manage a small portion of the university's endowment. He says the IEM helps them decide how the election might affect the health care stocks they've selected.
CHUCK MERSCH, MBA CANDIDATE, UNIVERSITY OF IOWA: I think at some point we'll see it up on the ticker with the Dow Jones and the S&P about which candidate is going up and down.
GERSH: The business school is so encouraged by the market's forecasting performance, it's now studying whether the IEM could be used to predict hurricane landfalls and flu outbreaks in addition to figuring out who has the best chance to be the next leader of the free world. Darren Gersh, NIGHTLY BUSINESS REPORT, Iowa City, Iowa.
