Paper Abstract

Volatility in Prediction Markets:
A Measure of Information Flow in Political Campaigns

Carlos M. Carvalho and Jill Rickershauser

June 2008

To appear in: The Handbook of Applied Bayesian Analysis
Eds: Tony O'Hagan & Mike West

In each U.S. presidential campaign, anecdotes that seem to summarize the election emerge, such as Bill Clinton's campaign slogan, "It's the economy, stupid," in 1992 and John Kennedy's performance in the televised debate against Richard Nixon in 1960. However, some stories may seem to epitomize the campaign when they actually did not alter the outcome of the election or even relate to the underlying factors that did influence the outcome. How can we adjudicate between the events that mattered and those that did not? Building on work in the market microstructure literature in economics, this paper builds a measure of information flow based on the returns and volume of the 'Bush wins the popular vote in 2004' futures contract on the Tradesports/Intrade prediction market. This measure allow us to associate a particular event to an information level, providing a direct way to evaluate its impact in the election. In the 2004 presidential race, our findings show that the televised debates, Kerry's acceptance speech at the Democratic convention, and several national security--related stories such as the report that explosives vanished in Iraq under the U.S.'s watch, the CBS story about Bush's National Guard service and the subsequent retraction, and the release of the bin Laden tape a few days before the election increased the information flow. Contrary to popular accounts of the election, we find that ads attacking Kerry's military service aired by the Swift Boat Veterans for Truth in August contributed only a limited amount of information to the campaign.