With less than 24 hours to go before the Iowa Caucuses, former Massachusetts governor Mitt Romney and Rep. Ron Paul (R-Texas) are are well positioned to finish first and second in the first voter test of the Republican field. That’s not just the consensus of pundits and armchair politicians — that’s the current outcome predicted by the Iowa Electronic Markets, perhaps the most avidly watched prediction market during any U.S. presidential election. Real traders with real money on the line, at the writing of this blog post, were giving Romney roughly an 86 percent probability, and Ron Paul around a 70 percent probability, of finishing in the top two when all the final results have been tallied by midnight.
Prediction markets, which burst into mainstream popularity after the release of James Surowiecki’s The Wisdom of Crowds, have become an increasingly sophisticated way to model the outcome of events when the range of possible outcomes is known. With less than 24 hours to go, the “crowd” appears to have written off Texas Governor Rick Perry and Rep. Michele Bachmann (R-Minn.) to the point where their contracts in the Iowa Electronic Markets are trading at close to zero. The crowd thinks that even former House speaker Newt Gingrich now has less than a 1 percent probability of finishing in the top two in Iowa — even after a surge in popularity at year-end.
In other words, does the crowd now think that a dark horse challenger like Rick Santorum or Jon Huntsman has close to a 40 percent probability of finishing in the top two? Or, for that matter, a total unknown like Gary Johnson?
Theoretically, the ROF contract should trade for close to zero on most days, and then spike on days when dark horse challengers like Chris Christie or Sarah Palin are rumored to be gearing up for an election bid. For example, the ROF contract traded at close to 25 cents in September when it was rumored that Sarah Palin would join the Republican field.
So, what does it mean when dark horse challengers are still in the running and the crowd is still willing to place bets on them, even with seemingly impossible odds?
The crowd may sometimes be mad and delusional, and the Iowa Electronic Markets do not always get it right. But what’s interesting is that the Republicans continue to shuffle through candidate after candidate, looking for someone who can beat Obama head-to-head. According to the crowd, none of the current Republican candidates — at least not anyone who’s currently in the field — can. The 2012 Presidential election may be one of those epic horse races where the pundits get it all wrong, and the crowd gets it all right. Will a dark horse candidate come out of nowhere to win the race at the end by a nose?
Read more news and ideas on Innovations: