Abstract
Prediction and betting markets have evolved with contracts based on electoral outcomes and the traded prices provide a measure of speculators’ views on electoral outcomes. Conversely, popular opinion polls yield data which provide statistics on the public’s declared voting intentions. This article formulates a model to describe the stochastic evolution of opinion polls, and the resultant probability distribution of seats won in the US House of Congress. Based on standard methods from financial option pricing theory, we can then determine the theoretical value of observed contracts in the prediction markets. Our results show that qualitative predictions are obeyed, but there exist significant deviations between the actual prices traded in the Iowa Electronic Market (IEM) and our theoretical valuation under real-world expectations. Some explanations are provided, which are consistent with conclusions drawn by other authors who have studied electoral prediction markets.
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