IE 11 is not supported. For an optimal experience visit our site on another browser.

Political markets go wild

As the political season reaches its peak, economists are seeing evidence that the fortunes of presidential candidates are not immune from bounces, crashes and even market manipulation.

The evidence shows up in the latest readings from political prediction markets - which have been more accurate indicators of an election's outcome than traditional opinion polls, based on a scientific analysis of the past 20 years of presidential campaigns.

The trades can be made with play money (as is the case for NewsFutures or Inkling), or with real money through offshore betting sites (like InTrade or BetFair). America's only officially sanctioned real-money operation is the Iowa Electronic Markets, a business research project at the University of Iowa.

IEM
The share prices for the winner-take-all presidential

market on the Iowa Electronic Markets are traced

over the past year on this chart. The blue line shows

Democratic prices, and the red line shows the GOP

prices. Republican prices peaked in April, toward the

end of the primary season; and again in September,

after the GOP convention. Click on the image for a

larger version from the IEM.

Whether you're using play money or real cash, the principle behind the winner-take-all prediction markets is the same: You buy into the market at the going price - for example, about 76.5 cents a share, if you're buying Democrat Barack Obama's stock on the IEM's winner-take-all market today. If Obama wins next month's election, your payoff is $1 a share. If he loses, you get zip, nada, nothing.

Joyce Berg, an accounting professor who is on the IEM's steering committee, said interest in the market's machinations have taken a sharp upturn since the summer, based on Web site traffic. "It looks like we've got about six times as many people coming in," she told me today.

There aren't all that many people actually putting their money down: About 2,500 have signed up to participate in the university's "experiment," and about 1,000 are involved in active trading at any one time. But researchers have found that it doesn't take thousands of people to produce meaningful results.

"What you really need in the market are just people who are interested in politics, and who ferret out information and factor that information into their trades," said University of Iowa spokesman Tom Snee.

The GOP crash

Recently, the information has been pretty dismal on the economic front, and that's probably what's been behind a downright crash in GOP candidate John McCain's IEM share values over the past three and a half weeks. The closing price went from 47 cents on Sept. 12 to 22.8 cents on Monday. That's the lowest price on the winner-take-all market since trading began for this election cycle, more than two years ago.

"McCain is testing the low," Snee said. (But it's not the absolute low mark for an election cycle. GOP candidate Bob Dole was down in the teens during the latter days of the 1996 campaign, Snee recalled.)

Other markets show similar lows for Republican fortunes, ranging from 31 cents on the dollar at InTrade and NewsFutures, to 21 cents at BetFair, to less than 13 cents on Inkling.

Could tonight's debate give McCain's stock a boost? You bet.

Although the IEM's researchers have said their market doesn't experience the dramatic post-convention bounces typically seen in political polls, there was a significant surge in the GOP shares after the widely heralded debut of Alaska Gov. Sarah Palin as McCain's running mate. Since then, however, the market enthusiasm has cooled.

"It was a real open issue as to what Palin was going to do to the ticket," Berg said.

The way she sees it, the ups and downs were driven by the expectations and the news surrounding Palin. But other analysts wonder whether the market can be manipulated by traders willing to lose money in order to make their guy look good (or at least less bad).

Manipulating political markets?

Justin Wolfers, an economist at Penn's Wharton School of Business who has studied the prediction markets for years, took note of an "odd pattern" on InTrade after the first presidential debate: Large stock orders were being executed at times when liquidity was scarce and there was little reason for a market shift - in such a way that McCain got a lift and Obama's stock was pushed down.

"Manipulation is nearly impossible to prove. But the trader placing the suspicious orders moved the contracts to price levels that weren't sustained, so it's nearly impossible that they made money on the transaction," Wolfers and fellow Wharton researcher David Rothschild wrote in their column for The Wall Street Journal. "That suggests to us that the trader had an ulterior motive, such as a desire to raise Sen. McCain's stock and alter the public perception of how the horserace was unfolding."

Analyst Nate Silver made similar observations on the FiveThirtyEight Weblog, which focuses on electoral projections.

InTrade may be more vulnerable to manipulation because it's more freewheeling than other markets. Opening accounts on the IEM, for example, are limited to $500, so it's harder for someone to come onto the scene and make a huge trade immediately. Strangely enough, the same built-in control applies to the play-money markets, where it takes some time to traders to amass a virtual fortune.

If you're looking for a market reality check, "the play-money markets are an excellent place to look," Wolfers told me.

Wolfers said tonight's presidential debate offers a big opportunity for price movement, but it's impossible to tell in advance which direction the move will take. The fact that the online trading might be subject to political gaming makes the job even tougher. Nevertheless, Wolfers says he'll continue to put his faith in the markets, from now until Election Day.

"That these markets are being manipulated is very, very likely, and that means they're not perfect," he admitted. "But I've often said that they're the least imperfect tool."

Update for 1:30 p.m. ET Oct. 8: Here's the morning-after market report (or, depending on your time zone, the afternoon-after or even evening-after report). The current quotes still favor Obama: IEM has a 78.8-21.6 breakdown for average prices, InTrade shows last trades of 73.5-26.4, BetFair has 80.1-18.8, Newsfutures shows 68-32, and Inkling has a 92-8 spread.

Check in with msnbc.com's Politics section to keep track of the debate and its aftermath.