Price Discrepancies and Presidential Election Odds

Nate over at FiveThirtyEight has observed a discrepancy between the prices for Obama over at Intrade (52.3 at the time of his writing) and at Betfair (61.7). I was pleased to see that he made none of the amateur errors I usually find when reading analyses of idea futures prices. Importantly, he recognizes that it is non-trvial to translate individual state odds into electoral vote victory odds.¹

However, he misses one possible explanation for the price discrepancy between the two markets which would not involve an arbitrage opportunity. His key oversight rests in the following statement:

Right now, Obama is trading at 52.3 points. That is, Intrade implies that he has a 52.3 percent chance to become the next President.

Nominatibility and Electability

Jason Briggeman over at Productivity Shock observed that the frontrunners for the Democratic and Republican 2008 presidential nominations, Hillary and McCain, seem to have lower electability (as implied by TradeSports/Intrade) than some of the other contenders, such as Gore and Rudy. He measures this electability by dividing their odds of becoming elected by their odds of becoming nominated (R / D). But this is a naïve calculation of electability (even disregarding the important market distortions that result from a contract with a two year duration).

At the time of this writing, the prices are as follows:

	Nomination	Election
McCain	54.0	29.6
Clinton	52.1	25.5
Giuliani	12.6	9.1
Gore	11.4	8.0

This suggests, according to the naïve calculation method, electability measures (in percent likelihood) of:

	Electability
McCain	54.8
Clinton	48.9
Giuliani	72.2
Gore	70.2

In other words, it looks as if the parties are likely to nominate precisely the candidates who would be less likely to get elected! (In the Democratic case, this couldn't even be explained by appealing to their base, as Gore is clearly more dear to the Democratic base than Hillary Clinton.)

But here's the thing. It's possible that, at this stage two years before the election, the market thinks that (for example) McCain and Giuliani are, on balance, just as electable, but that circumstances could make either one less electable, and that Giuliani would be less likely to be nominated given those circumstances than McCain would be.

This is a subtle point, so I'll explain it again. Electability is not a simple number. Rather, it is an average of numbers, given various possibilities. Perhaps Giuliani is more electable against some opponents than others. For example, perhaps Giuliani would handily beat Barack Obama, but have a tough time facing Al Gore. Or, perhaps, Giuliani would be very electable if certain issues were at the forefront of national attention at the time of the election (like, say, terrorism), but not other issues (like gay marriage?). How do we measure real electibility? To do so, we have to imagine a hypothetical scenario in which Giuliani were the only candidate for the Republican nomination. In other words, the price of 2008.GOP.NOM.GIULIANI would be equal to 100.0. In that hypothetical scenario, what then would be the price of 2008.PRES.GIULIANI (his election)? Maybe it would be close to 72.2, or maybe it would be closer to 50. Hard to say.

The fact that, in the real world, 2008.PRES.GIULIANI divided by 2008.GOP.NOM.GIULIANI happens to equal 72.2 simply means that, in those scenarios where Giuliani actually ends up being nominated, his electability averages 72.2. But his abstract electability, given the hypothetical scenario in which the Republican Party nominated him without considering other candidates, is not necessarily the same.

So perhaps the market thinks the party elders are wise after all. Perhaps McCain is more electable in most scenarios than Giuliani (thus giving him higher odds of the nomination), but the GOP will only nominate him in those scenarios, and will nominate Giuliani in the other, less likely scenarios.

It's also possible that the party elders are not so wise, but that the reasons for the discrepancy still have nothing to do with currently known electability. It could be that, as things stand, they both have an average likely electability of 50.0, but that McCain is much more likely to be nominated, given his socially conservative positions, higher profile, and increased party ties, than Giuliani. In other words, their average possible electability (as measured right now) could be the same, but McCain has an edge in the nomination process that can overcome lower electability at the time of nomination. That doesn't mean he's predicted to have lower electability at that time -- just that he can overcome it in the nomination process, should it be the case.

If you're still having trouble understanding, here's an analogy: Every so often, while walking down the sidewalk, people discover $20 bills. They then motion to pick them up. If you see someone leaning down and gesturing as if they're picking up money, they probably are! But that doesn't mean that if you go walking down the sidewalk, gesturing as such, that $20 bills would magically appear in your hand.

By comparison, maybe the Republicans will nominate Giuliani if it makes sense for them to. And if it does make sense, maybe he has a very good shot at actually winning the presidency. But it won't necessarily make sense in the first place, and circumstances at the time of nomination will determine whether it does.

The reality is probably somewhere in between. McCain might be more electable, but more nominatible than his increased electability deserves, due to his greater party ties.

The same analysis applies to Clinton vs. Gore, or any other possible candidates. (Again, this ignores the very important market distortions that must be present.)

Put this way, it's not a surprise that candidates with greater party ties have a greater chance of being nominated than their electability deserves. But that's not the same thing as saying that their electability is actually lower than that of their competition.

Buffett's Charity No Surprise

Why is everyone shocked at the news that Buffett is giving most of his wealth to charity? He wrote in his 2005 letter to shareholders:

Every share of Berkshire that I own is destined to go to philanthropies

Tim Russert Doesn't Understand Basic Economics

Here's a clip from this Sunday's "special edition" of Meet the Press on high gas prices. Simply astonishing:



I love the expression on Bodman's face. First, one of confusion: "Did he really just ask me that question?" Then shock: "Holy shit, he really asked me that question." Then, after his brief answer, he just stared at Russert like he was an idiot, and there was silence. Full video of the show here, and full transcript here.

I guess Tim Russert doesn't read Charles Krauthammer.

Big things

It's interesting how the Pyramids are considered a monument to Egyptian civilization but the Ryugyong Hotel is considered an embarrassment to North Korea.

Iraqi Casualties

24 year old Bush worker, gets appointed to Nasa, to discount Big Bang

Pretty annoying.

Update 2/8/2006: He has now resigned. I seem to have a good track record in which Bush appointees I would like to resign.

Free speech...

John Kerry criticizes someone exercising his right to free speech who criticized someone else who exercised his right to free speech, on the grounds that you shouldn't criticize people since they have the right to free speech.

Gaza Withdrawal

Some good analysis of the Gaza withdrawal here and here (via InstaPundit).

Gates of Fire

A pretty gripping account of combat in Iraq, complete with photos (via InstaPundit).

Progress in Iraq?

This article (via InstaPundit) is surreal. In it, Kofi Annan takes credit on behalf of the United Nations for the progress in Iraq. Yes, the same United Nations that stood in the way of progress. The same United Nations that cut and run from Iraq as soon as it got difficult. And the same Kofi Annan that called the Iraq War a violation of international law.

My God

Spotting criminals in nursery school (via Pej)

Children as young as 3 should be identified as potential criminals if they're bullying other kids or have criminal parents, recommends a crime reduction report to British Prime Minister Tony Blair.