Looking at the University of Iowa GOP Iowa Caucus Market, you could create these headlines:
- “Gingrich gains.”
- “Cain crashes.”
- Perry plummets.
- Romney remains.
With quotes indicated every 15 minutes, the University of Iowa prediction market for the Republican presidential nomination is a fascinating barometer. Pre-debate gaffe, the price of a Perry contract was 31 cents. After the debate, it nose-dived to 17 cents. For Romney, the average price of a contract remained in the vicinity of 80 cents. Meanwhile Cain moved down, 47 cents to 22 cents, and Gingrich moved up from 8 cents to 36 cents.
The Iowa Electronic Market indicates the probability that a candidate will finish in the top 2 in the Iowa caucuses. So, a 22-cent contract displays a 22% probability. Like any market, price fluctuates because of supply and demand.
Explained on the IEM website, “Contracts for the correct outcome pay off at $1, all other contracts pay off at zero. As a result, the price of the contract at any given time is the probability that the traders believe that event will happen.” The maximum investment is $500.
The Economic Lesson
Can a crowd be smarter than an individual? In The Wisdom of Crowds, financial writer James Surowiecki, says “Sometimes, yes.” Starting with a crowd betting on the weight of an ox and ending with the crowd and democracy, Surowiecki looks at “collective intelligence.”
Surowiecki divides “collective intelligence” into 3 categories:
- Cooperation problems focus on how people work together. The issues they look at include legislative compromise (or gridlock) and getting a large group together for a dinner.
- Coordination problems display how many independent individuals impersonally coordinate their behavior. Examples would take us to rush hour traffic and stock markets.
- Cognition problems involve information that makes one answer more accurate than another. Predicting future monetary policy, the future weight of an ox, and who will win the Iowa Caucuses are cognition problems.
An Economic Question: Thinking of prediction markets, how could a demand/supply graph demonstrate a candidate’s poor performance during a debate?