Abstract:
Prediction and betting markets have evolved with contracts based on electoral
outcomes and the traded prices provide a measure of speculators’ views on electoral
outcomes. Conversely, popular opinion polls yield data which provide statistics on the
public’s declared voting intentions. This article formulates a model to describe the
stochastic evolution of opinion polls, and the resultant probability distribution of seats
won in the US House of Congress. Based on standard methods from financial option
pricing theory, we can then determine the theoretical value of observed contracts in
the prediction markets. Our results show that qualitative predictions are obeyed, but
there exist significant deviations between the actual prices traded in the Iowa
Electronic Market (IEM) and our theoretical valuation under real-world expectations.
Some explanations are provided, which are consistent with conclusions drawn by
other authors who have studied electoral prediction markets.
