Betting on the Futures of Politics

Sometimes she confers with financial analyst Alex Forshaw, who has also bet on Intrade, before hedging a bet. Forshaw believes investors should make cautious predictions. "When I was in college, I didn't do much besides bet on political outcomes. It worked very well, but I got overconfident, and my model 'blinked' for about two weeks out of 10 months, which was enough to cost me everything I'd gained," he said.

Still, Forshaw tracks market trends because he believes most investors are wiser than that. "Anybody who thinks his opinion is materially different from the herd's, and meaningfully more predictive, should invest in the futures markets," he said. "The market is a democracy in the short run and a meritocracy in the long run. It punishes stupidity of academics and political 'experts' just as ruthlessly as it punishes the stupidity of overconfident college students."

Intrade's Vice President of Business Development Chad Rigetti believes the markets often are more insightful than polls. "Polls do not respond to news in real time. Market prices do," he said.

Yet while investors respond quickly to some events, they react cautiously to others.

While McCain's standing in the polls noticeably improved immediately after the Republican National Convention and his choice of Palin as his running mate in early September, the price of shares tied to McCain on Intrade barely changed.

From his perch at the Wharton School of the University of Pennsylvania, Professor of Business and Public Policy Justin Wolfers watched the market daily. "The two weeks after the convention were the two most stable weeks in the markets," he said. "Markets were quite unimpressed by the choreography of the conventions and correctly responded."

Most investors, he explained, realize voters ultimately vote for the top of the ticket, rather than the bottom. "They were not going to place more or less money on a prediction regardless of public sentiment reflected in polls," he said.

With convention bounces all but faded, national polling -- which currently shows Obama with a four-point lead over McCain, according to an aggregation of polls by Real Clear Politics -- is more in line with Intrade's market.

Karlan, the Yale economics professor, said that when he is around a group of economists, "people will talk about the Intrade odds much more than poll data." Karlan believes the data's worth watching because "You're not going to invest thousands of dollars unless you know something beyond the average voter."

Prediction markets predate polls and were considered a reliable source to track political trends in the early 1900s. Polling emerged as a source of political intelligence in the 1930s. "If you go back to the 1912 election, large-scale prediction markets were the basis of [forecasting] the race," said Wolfers.

These markets subsequently declined in importance, but made a comeback after accurate political forecasts in 2004, according to Professor Keith Chen of Yale. "Intrade investors who bet on the electoral college map, accurately predicted that the presidential candidate to win Iowa would win the election," said Chen. They based their predictions off of mathematical calculations.

These speculators predicted the number of states President Bush and Democratic challenger John Kerry were likely to carry and ranked the likelihood of each. The candidate who could win Iowa, they determined, would win all of the states needed to enter the White House. On Election Day, Bush won Iowa, and all of the other states calculated in his favor. Polls, however, speculated otherwise. Election day exit polls suggested Kerry would win the popular vote, based on a widespread belief that he would win the electoral-rich state of Ohio. That night, Kerry lost Ohio and lost the election.

During this election cycle, Chen says economists applying the probability formula to investments say Nevada will be the pivotal state. While some polls suggest that Ohio is again the battle-ground state likely to determine the election, economists like Chen will watch Nevada. Investors believe the winner of Nevada will win the necessary electoral votes from other swing states to claim victory.

And what happens once the election's over? What will economists and politically savvy investors like Lilja bet on the markets? Contracts tied to potential policies of the next Congress and the state of our economy -- already growing in value -- could become the next jackpot.