Since our latest analysis appeared in the AFR and, for the first time, the SMH, there has been some chatter on Twitter about the legitimacy of using betting odds to make predictions. We’ve written about the strengths and weaknesses of betting markets before, but wanted to address a few specific criticisms.
Betting markets certainly have their weaknesses. They don’t work if there aren’t enough people betting. They suffer from longshot bias. And some situations are just so uncertain that no prediction method, including prediction markets, can offer much additional insight (a good example of this is the election of the Pope, where only a handful of people in the world have any useful knowledge about the outcome).
Myth #1: Betting markets were lousy in the 2010 election.
This is not right. The electorate-level betting data (which we use) predicted a hung parliament in 2010, with Labor expected to win 74 seats. This is a remarkable result, given the 2010 election was probably one of the toughest election outcomes to predict in Australian history.
Myth #2: Betting markets just track polls.
Betting markets aggregate information from many sources, including polls. But betting markets and polls measure different things. Polls track instantaneous voter sentiment; betting markets track the probability of victory over time. So while we’d expect a bump in the polls to be noticed by the betting markets, you’d expect the markets to be cautious about weighting them too heavily. That’s exactly what we’ve seen in this campaign. While the Labor victory probability has usually moved up and down with the polls, at no point has Labor been anywhere near the favourite in the betting odds. That’s a very important qualitative difference between the betting odds and the polls (which have recently suggested the race is neck-and-neck).
Myth #3: Betting markets predicted a landslide in election X, but the result ended up being very close.
A probability of victory implied by betting odds is not a prediction of vote proportion. A 90% probability of Labor victory is not a prediction that Labor will win 90% of the vote; the market may just be very confident Labor will win 76 seats. So, for example, while the odds for the overall election result in 2010 were putting Labor on as much as a 70% chance of forming government, this doesn’t say anything about the expected margin of victory. It simply says the markets were moderately confident Labor would form government (which it did).
Betting markets aren’t perfect. But we think they’re a really promising tool for making predictions in very uncertain situations, such as elections. We’re still a long way from election day, but we expect our predictions to become more and more accurate as it draws closer.