Economists LOVE prediction markets. And why not? Economists love markets and prediction markets have a pretty good track record. But I am an economist and I find little to love about these markets when it comes to politics. Above you see the current price for an Obama victory on Tuesday at Intrade. Currently, Intrade is pricing about a 84% chance of an Obama victory. That seems to make sense given what the polls and pundits are saying today, but wait, what is this less than 50% chance in the middle of September? Oh right, this is the post-convention bounce for McCain. But if prediction markets are somehow "wiser" than individual polls or pundits (or even a collection of polls and pundits) why has this mirrored them so closely? Shouldn't these wise 'crowds' have figured in the temporary bounce?
The reason for my view is simple: these markets are incomplete due to a lack of information and so while on average the mass participation should bring the variance down, individual markets are not telling us much that we don't already know. Investors in these markets are not privy to special information, they are guessing what other people will do. A recent look at the roller coaster that has been the Dow Jones Average this month should show you how good markets are at figuring that out.