Election Stock Market
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Igodard
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/* Examples of election stock markets */
'''Election stock markets''' are [[financial markets]] in which the ultimate values of the contracts being traded are based on the outcome of [[elections]]. Participants invest their own funds, buy and sell listed contracts, earn profits and bear the risk of losing money. Election stock markets function like other [[futures exchange]]s, such as commodity exchanges for the future delivery of [[cereal|grain]], [[livestock]], or [[precious metals]].
The main purpose of an election stock market is to predict the election outcome, such as the share of the popular vote each party receives, or the share of seats in the [[House of Representatives]], [[Parliament]], or Legislature. Efficient markets are very good at reflecting all available information. They often reflect information faster than [[opinion polls]], which take several days to complete and process. Traders also have a strong financial incentive to reflect their true opinion about the election outcome, regardless of their political preferences.
Election Stock Markets are also used for research and teaching purposes. Researchers can study trader behavior and market operations. Election Stock Markets also teach participants the fundamentals of trading, such as how to take a ''[[long (finance)|long]]'' or a ''[[short (finance)|short]]'' position.
==Examples of election stock markets==
In [[North America]], two universities have been operating Election Stock Markets for over a decade. The [[University of Iowa]]'s [[Tippie College of Business]] has been operating the [[Iowa Electronic Markets]] [http://www.biz.uiowa.edu/iem]. The Iowa markets primarily track presidential and congressional elections. In [[Canada]], the [[University of British Columbia]]'s [[Sauder School of Business]] has been operating the '''UBC Election Stock Market''' [http://esm.ubc.ca/]. The UBC markets track federal and provincial elections in Canada. The Iowa and UBC markets are non-profit operations for research purposes. These markets do not charge commissions or transaction fees. Investments are typically limited to USD 500 or CAD 1,000.
Recently, privately run exchanges have challenged university election markets. [[Tradesports]] and [[Betfair]] are the two largest private exchanges running election markets. Tradesports and Betfair have attracted more volumes than their academic counterparts as they don't limit a trader's capital investment. The '''Washington Stock Exchange''' [http://www.thewsx.com/] tracks predictions for broader political events, including presidential nominations.
==How do election stock markets work?==
===Types of markets===
Election stock markets typically cover the [[popular vote]] share of [[political parties]] or the seats share of political parties in a parliament. The seats distribution depends on the electoral system (such as first-past-the-post or proportional representation) that is used for the particular election. Predictions of seats distributions are therefore often more challenging than predictions of vote shares. The ultimate payoff in a votes share or seats share market is determined by the actual distribution of votes and seats as determined by the election. For example, if the Blue Party wins 32.3% of the popular vote, than the corresponding contract in the popular vote market would pay out 32.3 cents.
Election stock markets may also offer winner-take-all markets. In such markets only one contract will pay $1, and all other contracts pay $0. Winner-take-all markets are commonly used to predict outcomes such as the winner of a presidential election or the formation of a majority government by a particular party. Such markets may also be used to predict the outcome of a referendum.
===Trading contracts===
Traders buy and sell contracts, which are typically quoted in 1/10-th of a cent corresponding to 1/10-th of a percentage point for the votes share or seats share of a political party. Traders make profits by buying undervalued contracts and selling overvalued contracts. If a trader expects the Blue Party to win 42.3% of the popular vote, the trader will find it profitable to buy a contract of the Blue Party if a seller offers it for less than 42.3 cents. The same trader will find it profitable to sell the same contract if another trader is willing to buy it for more than 42.3 cents.
===Taking a long position===
A trader takes a ''long'' position by buying low and selling high. Consider an investor who considers the purchase of a contract in the Blue Party, which is currently offered for 39.3 cents in the market. The investor predicts that the Blue Party will win more than 41%, and buys a contract of the Blue Party for 39.3 cents. On election day the Blue Party wins 42.5% of the popular vote, and the trader realizes a profit of 3.2 cents, an 8.1% return on investment.
===Creating contracts===
Contracts are put into circulation through the purchase of a ''unit portfolio''. A trader purchases a set of all contracts in a particular market worth $1. Consider an election in which three parties compete, a Red Party, a Blue Party, and a Green Party. The share of popular votes for each party must sum to 100% by definition, so holding on to one contract for each of the three parties will always be worth $1 no matter what the election outcome. Buying unit portfolios allows trader to take a ''short position'' by selling contracts that they think are overvalued.
===Taking a short position===
Consider a trader who has bought a unit portfolio consisting of one contract each for the Red Party, the Blue Party, and the Green Party, at a cost of $1. Now the trader sells one contract of the Blue Party for 30 cents. On election day the Red Party wins 55% of the vote, the Blue Party wins 25% of the vote, and the Green Party wins 20%. The trader now receives 75 cents in total for the Red Party and Green Party contracts, and has an additional 30 cents from the sale of the Blue Party contract. The trader has now $1.05 and has made a profit of 5 cents on an investment of $1.
===Market Liquidation===
Election Stock Markets typically cease trading the day before the election is held. The markets are liquidated after the election based on the election outcome. In markets for the popular vote share and the parliamentary seats share, each contract is valued precisely equal to the corresponding percentage share. In winner-takes-all markets, the winning contract pays $1, while the losing contracts pay $0.
[[Category:Prediction markets]]