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Friday, May 29th, 2015


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School Stock Market Mixes Politics & Investing

You’ve been telling your friends for months now about how a George W. Bush win in November is inevitable or how the polls favor the famously strong-closing Kerry. In your mind, the presidential race is already over. But are you willing to put your money where your mouth is?

The Iowa Electronic Markets will let you do just that. The real-money futures markets, started in 1988 by a group of University of Iowa professors, allows traders to buy shares of political candidates and – if they’re lucky – sell them later for a tidy profit.

The idea came about when George Nuemann, Forrest Nelson and Bob Forsythe – – all UI economics professors – went to lunch together shortly after Jesse Jackson’s victory in the Michigan Democratic primary election in March of 1988.

The major media polls had failed to predict Jackson’s win and, as Nelson recalls, somebody at the lunch said, “If the Chicago corn futures markets were doing as poorly predicting the price of corn in November as these polls are doing predicting tomorrow’s election, they wouldn’t exist.”

The three decided to test their theory that a market would outperform polls in predicting election outcomes, and thus was born the Iowa Political Stock Market. The endeavor was re-christened as the IEM in 1996 when board members decided to add markets on non-political futures like stock prices and box-office returns.

With the help of Jack Wright, then a UI political science professor, the group set up a one-semester-hour class in which students traded shares. The market was up and running by June, and when results came in for the general election, the market was the clear victor over the polls.

While the major media polls missed the margin of George H. W. Bush’s victory over Michael Dukakis by nearly three percentage points, the market erred by barely one half of one percent. Since then, the market has continued to outperform polls, with the notable exception of the 1996 presidential election, when Forsythe says investors became “overly optimistic” about Bill Clinton’s probable margin of victory.

So why does a money market whose traders are disproportionately white, male, well-educated and Republican outperform polls that take a representative sampling into account? It’s a matter of incentive, board members say.

“When some pollster calls me up on a Sunday night and interrupts the football game I’m watching, I just want to get him off the phone as quickly as I can,” Nelson explains.

While Joe Average might name off the first candidate that comes to mind when talking to pollster, he’ll likely put a lot more effort into his answer once his own money is at stake.

“I don’t think most people actually lie to pollsters,” says Forsythe. “But if there’s nothing on the line, I don’t think they really think about it.”

This doesn’t mean that traders think harder about whom they’ll vote for and then invest in that candidate. Rather, they synthesize all available information – everything from polls and news reports to barbershop anecdotes – to decide which candidate is doing better.

“Who should be elected, that’s personal preference. That’s what your heart says,” says Thomas Gruca, a marketing professor and IEM board member. “But who’s going to get the majority of the popular vote, that’s what your head says. That’s a rational decision.”

If a trader thinks that Bush has a 60 percent chance of winning, then, it would be rational to buy Bush shares at any price below 60 cents. If Bush wins the election, those shares will be worth a dollar apiece, and Kerry shares will be worth nothing – and vice versa.

Forsythe says that many investors in fact trade with their hearts and not their heads – meaning that Democrats are more likely than Republicans to buy Kerry shares at a given price. The markets find their equilibrium price through the activity of the 10-15 percent of traders known as “marginal traders.” These money-minded investors tend to do most of the price setting, while the more partisan average traders simply buy up the stock.

Although the market has a maximum investment of $500, traders can make a considerable profit if they play their cards right. Late last year, Kerry shares in the Democratic nomination market traded for under a nickel; they’re now near a dollar (they’re still under 97 cents, as a few people have held on to their Hillary Clinton shares as a sort of a market Hail Mary).

Anybody with $5 can open an account with the IEM. To find out how, visit www.biz.uiowa.edu/iem. But be careful about what you think you know.

“It’s mostly hunches,” Nelson says. “Most people tend to exaggerate the quality of their own knowledge.”

 

© 2008, Young Money Media, LLC. All rights reserved.

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