Feb. 14, 2008
Analysis: IEM more accurate at predicting elections than polls from 1988 to 2004
In its first 20 years, the Iowa Electronic Markets have turned out to be a better predictor of presidential election outcomes than public opinion polls, according to a new analysis by researchers at the University of Iowa's Tippie College of Business.
The research also found that the IEM was more accurate in its predictions earlier in the election cycle, and its margin of error was significantly less than public opinion polls.
The research was conducted by Joyce Berg, professor of accounting, Forrest Nelson, professor of economics, and Tom Rietz, professor of finance, who are also members of the IEM steering committee. Their paper, "Prediction Market Accuracy in the Long Run," will be published in a forthcoming issue of the International Journal of Forecasting.
Their work compared the predicted results on the IEM's vote share market to the published results of 964 public opinion polls in every presidential election between 1988 and 2004. The research found the election outcome predicted by the IEM was closer to the actual outcome 74 percent of the time from the date the market opened.
More than 100 days out from an election, the IEM was also more accurate 74 percent of the time. Polls narrowed the gap during the final five days before the election, but the IEM was still more accurate 68 percent of the time.
The biggest disparity was the period 66 to 100 days before an election, when the IEM beat the polls 84 percent of the time. Researchers suggest this gap was caused by the so-called "convention bounce," when a candidate temporarily jumped in the polls because of favorable public opinion following his party's nominating convention.
This bounce, however, is not reflected in the markets, which stay largely stable during and after the conventions. Since the conventions were held during the period 66 to 100 days before the election, the polls taken during that time were influenced by the bounce but the markets weren't, giving the IEM's predictions greater accuracy.
Berg, the director of the IEM, said the market is more accurate for several reasons. First, the market uses real money. Investors on the IEM open accounts of between $5 and $500 and trade contracts based on which candidate or party they think will win a presidential election. With real money at stake, she said investors base their decisions on who they think will win, as opposed to polls, which asks voters who they want to win.
Berg said IEM investors are also self-selected. That is, they join the market voluntarily and tend to be people who are interested in politics and so are highly informed people. Polls, even those that screen to include only likely voters, talk with people who may not be as informed. This gives the market a "wisdom of crowds" quality that polls lack.
On top of that, she said polls aren't always supposed to be predictors of election outcomes.
"Polls tend to be a static, one-time prediction," she said. "The market is a dynamic system that can respond instantaneously to the arrival of new information and asks traders to forecast how everyone will vote in the actual upcoming election, not just how they will vote."
Additionally, the new research found the IEM's margin of error was significantly less across all time periods. Overall, the IEM's margin of error was 1.82 percent, while the polls margin of error was 3.37 percent.
In the five days immediately before an election, the IEM had a margin of error of 1.11 percent, while polls had a margin of error of 1.62 percent. Prior to 100 days before an election, the IEM had a 2.65 margin of error, while the polls had a 4.49 margin of error.
The market's accuracy was noted this month in a story about the IEM in Scientific American.
The IEM was begun in 1988 after Jesse Jackson surprised pollsters and pundits by winning the Democratic Party primary in Michigan. Several faculty members in the Tippie College of Business wondered if a futures prediction market could more accurately predict election outcomes and see something like the upset Jackson victory in Michigan in advance.
They established the IEM as an electronic, online futures trading market in time for the Michael Dukakis-George H.W. Bush election in November 1988. That first year, the market had only 155 traders, most of them UI faculty and students. So far, during the 2008 election season, more than 2,000 traders are participating in the IEM presidential nominating and election markets, most of them from outside Iowa.
The IEM can be found online at http://www.biz.uiowa.edu/iem. Nominating market prices can be found at http://iemweb.biz.uiowa.edu/quotes/Nomination08_Quotes.html.
STORY SOURCE: University of Iowa News Service, 300 Plaza Centre One, Iowa City, Iowa 52242-2500
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