Futures Markets: Money where the mouth is

I've been meaning for weeks now to write about this topic - the fascinating predictive powers of futures markets - and time's quickly running out for it to have any relevance to tonight's Canadian election. The Globe, Post, Star and CBC have all reported on it, and the polls closed in Newfoundland an hour and a half ago, but I'm still going to take a stab at writing something noteworthy.

In simple terms - for my fellow engineers and non-MBA types - futures markets allow people to bet on the outcome of a future event. They've existed for decades - if not longer - in commodities markets, with traders buying and selling futures in oil & gas, produce, precious metals, and of course, pork bellies.

At the risk of offending pork belly traders, futures markets have become infinitely more interesting to the average observer, mainly with the Internet brining the concept to the masses with futures markets in everything from sporting events to elections. What's more, the results of these markets have been astounding in their predictive abilities. Some notable examples include:

• Intrade - The Dublin-based market showed that the probability of Saddam Hussein's capture more than tripled the day before his capture. Remember that his capture was a relative surprise to begin with, let alone on that day.


• Iowa Election Exchange - Over the course of 5 presidential elections spanning 12 years, the University of Iowa's election futures markets predicted the popular vote within 1.4%.


• University of British Columbia - In the 2000 election, UBC's futures market was remarkably close in its seat predictions, and accurate within 1.5% for each of the five parties in popular vote.


• Hollywood Stock Exchange - Harvard researchers have concluded that HSX's futures-based box office predictions are accurate to within 16% of actual receipts, more accurate than any other single means of forecasting.

The theory behind the predictive abilities of futures markets - compared to even the most statistically significant polls - is that traders have to put their money where their mouths are. Moreover, the theory holds that the more educated a trader is on the likely outcome, the more he/she will invest in their bet. In the case of an election, the traders don't even have to represent the actual voters to predict the outcome better than polls.

Whatever the theory, the results speak for themselves. And the predictions for tonight's election? Check back in a minute!