Real Money Says Ron Paul Has a Shot

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In addition to being a mild-mannered economist by day, I am an avid fan of gambling and all its devices. (Though since I still am the property of student lender Sallie Mae, I have been a mere spectator of the gambling world for the last several years.) I am here to inform Ron Paul fans that "the market" — the gambling website Intrade.com — says his chances of winning the GOP nomination are now 6.1%. In contrast, McCain’s chances are 5.4%, and Huckabee’s a meager 3.2%.

Beyond the fact that Ron Paul is now in 4th place — and being ahead of McCain, is now surely a "real" candidate — is his meteoric rise since late May. Just look at this chart from Intrade:

To make sense of all this, let me briefly explain how Intrade works. It is fashioned after a futures market (such as in oil or pork bellies), where participants can buy or sell contracts contingent on future events. Now in the case of the "2008.GOP.NOM.PAUL" contract, the buyer (as of October 2) pays $6.10 for a contract entitling him to a $100 payoff if Ron Paul gets the Republican nomination. In contrast, the seller of this contract receives $6.10, but might have to pay out the $100 if Paul gets the nomination. Obviously, if Ron Paul doesn’t get nominated, then the buyer of the contract gets nothing — he’s out his $6.10 — and the seller gets to pocket the $6.10.

There are imperfections due to transaction costs and other frictions, but the probabilities of all the possible outcomes should sum (close to) 100%, because otherwise there would be pure arbitrage opportunities. For example, if the sum of the contract prices totaled only $98, then someone could buy one of each, and be guaranteed a profit of $2 (since one of the contracts would "hit"). On the other hand, if the contracts summed to $103, then someone could sell one of each, earning $103, and then only have to pay out $100 when one of them hit — thus netting a guaranteed profit of $3. So generally speaking, the contract prices should all sum to $100.

Of course, people with inside information stand to profit by trading in this market. If a technician at a health clinic comes across a very disturbing heart exam for McCain, that person could rush out and sell contracts on McCain’s nomination — and thereby push down the price of a McCain contract. On the other hand, if a Romney campaign staffer learned that Mitt was going to receive an honorary degree from a university, he could rush to buy contracts on his candidate, and thereby push up their price.

It’s because of the arbitrage element, and the fact that people with inside information can trade on it, that leads economists to loosely say that "the market" assigns a probability of (right now) 6.1% to a Ron Paul nomination. Sure, there are all sorts of objections you could raise to that type of talk; some purists reject the very idea of statistical language in the arena of politics. But you get the idea.

Before closing, let me stress two final points. First, this isn’t some Podunk contract that four hicks (who like to spam Fox voting schemes) are trading back and forth. No, when last I checked, the volume was over 63,000 Ron Paul contracts being transacted. (So if this is manipulation, it’s very very expensive.)

Second, some readers might be thinking, "Big deal! Ron’s gotten much higher than 6.1% in various straw polls and other surveys." But that’s just the thing, folks, and why I’m so excited about this. The Intrade contract isn’t asking, "Which candidate do you want to be nominated?" It’s asking, "Which candidate do you predict will be nominated?"

And I think it’s incredibly encouraging — for lovers of liberty, that is — that Ron Paul has broken through the 6% mark, and is now in 4th place. The great thing is, the three front-runners are only a gaffe away from forfeiting their position, just as McCain did with his immigration photo op with Ted Kennedy. In contrast, everybody already knows what Ron Paul stands for; he doesn’t need to delicately protect his carefully scripted image.

The pundits are still dismissing Ron Paul as a fringe candidate who isn’t "serious." Well, there’s a lot of actual money on the table saying that he is indeed a contender for the GOP nomination.

Bob Murphy [send him mail] has a Ph.D. in economics from New York University, and is the author of The Politically Incorrect Guide to Capitalism. He has a personal website at ConsultingByRPM.com

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