Price Dynamics in Political Prediction Markets

Saikat Ray Majumder 

Wednesdays@NICO Seminar, Noon, March 12 2008, Chambers Hall, Lower Level

Prof. Saikat Ray Majumder, Northwestern University

Abstract 

Prediction markets, in which contract prices are used to forecast future events, are increasingly applied to various domains ranging from political contests to scientific breakthroughs. However, the dynamics of such markets are not well understood. Here, we study the return dynamics of the oldest, most data-rich prediction markets, the Iowa Electronic Presidential Election "Winner-takes-all'' markets. As with other financial markets, we find uncorrelated returns, power-law decaying volatility correlations and, usually, power-law decaying distributions of returns. However, unlike other financial markets, we find diverging volatilities as the contract settlement date approaches. We propose a dynamic binary option model that captures all features of the empirical data and can potentially provide a tool with which one may extract true information events from a price time series.

Paper co-authored by Luis Amaral, Daniel Diermeier and Tom Reitz(U of Iowa).