When The Insiders Failed To Turn Up: Political Betting Markets.
In their article "The behaviour of betting and currency markets on the night of the EU referendum" Linton and Auld
examined the efficiency of the Betfair and pound/dollar markets as the results of the United Kingdom European Union membership referendum were announced.
They concluded that - " Not only was the currency market informationally inefficient, so too was the betting market, and both markets violated semi-strong EMH on the night of the vote.....Our results suggest that market participants suffered a behavioural bias as the results unfolded. It appears that traders and gamblers simply could not believe that the UK was voting to leave the EU. "
Despite considerable evidence to the contrary the notion that people who trade political betting markets have access to privileged information continues to dominate the narrative on social media. Even the so-called experts fall in to the trap. Professor Leighton Vaughan Williams Head of Economics Research and Director of the Betting Research Unit and Political Forecasting Unit at Nottingham Business School famously tweeted the following tweets in 2017 just before the Conservative Party lost their majority in a snap general election.
The notion of informed money backing the Tories at 1/5 on smacked of a man who had not only drank the Kool Aid, but who had succumbed to wishful thinking, confirmation bias and motivated reasoning. They still quote him on Bloomberg and refer to him as a betting expert.
And they still put forward the notion that political betting markets are full of rational, sophisticated traders who upadate their beliefs in response to new information and who collectively provide a quantifiable assessment of the wisdom of the crowd. Sure it makes for a great story, boosts egos and keeps the
bookmakers in profit.
The communications theorist Paul Watzlawick wrote that a phenomenon remains unexplainable as long as the range of observation is not wide enough to include the context in which the phenomenon occurs. Failure to realise the intricacies of the relationships between the matrix in which it takes place, induces one to attribute to his object or study certain properties the object may not possess. Betting markets ascribe probabilities to political events - but, more often than not these probabilities are being scrambled together on the back of incomplete information and are actually nothing other than the product of wishful thinking.
One hour after polls closed in the Brexit Referendum, the implied probability, on Betfair, the world's largest betting exchange, that the UK would vote to remain in Europe was 94%! Many people accordingly went to bed, believing that the vote was a done deal.
The most surprised, come the next morning, were the FX traders, who awoke at 4am to take their taxis into work, to find that the UK had actually voted for Brexit. Many of them had put their faith in the betting markets, and bet that the pound would rise significantly on the back of a vote to stay in the European Union.
The following two tables reveal the extent to which sterling volatility eased off as a remain vote appeared to look more certain (the second table is a snapshot of the Betfair EU Referendum betting market with sixty five million pounds traded and hardly a penny looking to get on the Brexit outcome.)
The stance that had been adopted by the majority of FX traders, represented a serious case of overconfidence - they had fallen into the age old trap of believing that they knew more than they actually could have known: or, putting it another way, they had been duped into believing that betting markets were omnipotent and contained some additional inside information about the outcome of the EU referendum that the polls had missed, and they chose to slavishly follow them. (Kahneman; When they come together, the emotional, cognitive and social factors
that support exagerated optimism are a heady brew.)
It was not the first time in the recent past that the betting markets had failed to adapt in response to new information. A previous, and recent humiliation had occured in relation to the Greek Referendum vote. Traders on Betfair, in particular, got it badly wrong, with the betting market on the event showing a 75% implied probability of a YES vote, as polling closed, seemingly ignoring a Guardian's poll of polls that had predicted a No vote.
The result of the Greek Referendum also represented a significant blow for the prediction market fanboy Justin Wolfers, who in an article in the NYT on the Greek Referendum (quoting Betfair prices) had written; as they adjust betting odds in response to the flow of money, their odds come to represent a quantifiable assessment of the conventional wisdom. The problem, for Wolfers, being that the conventional wisdom simply did not adjust in response to the polls, indeed if anything, those of us that closely watched activity in the market ahead of the vote announcement, noted a very distinct homophily effect at work, with the betting market simply moving in line with the pronouncements being made by other traders on Twitter that had voted yes. Contrary to the notion of prediction market traders as being actively open-minded thinkers, willing to change their minds and to abandon their old views easily - the example of the Greek Referendum pointed to them as being prone to anchoring down and failing to respond to new information.
Greek Referendum 2015 Polls*
Source: Guardian (Average of Six Polls).
Greek Referendum 2015 Betting Exchange*
Closer to home, on the eve of the 2015 UK General Election, the implied probability of a Conservative Majority (the actual outcome) on Betfair was 7%.
The implied probability of there being no overall majority in the House of Commons was 91 per cent. Six days later the Tories had won 330 of the 650 seats — an overall majority.
Source: Betfair Betting Exchange.
Whilst speaking about his pre-election forecast on the 2015 UK General Election, Nate Silver said:
The forecast assigned too little of a chance to an outcome like this one, especially given that there have been significant polling errors in the UK before. It is a good lesson as we begin to plan our coverage for the 2016 U.S. election.
In July 2015 Silver wrote as regards Donald Trump's Presidential propsects; In the long run — as our experience with past trolls shows — Trump’s support will probably fade. Or at least, given his high unfavorable ratings, it will plateau, and other candidates will surpass him as the rest of the field consolidates.
On 7 October 2016, Donald Trump saw fit to mock Silver: He's always been on the right side of what happened and he didn't predict me.
The notion that betting markets are omnipotent and somehow capable of pricing in all of the available information pertains, not least on twitter. Speaking on the subject of prediction/betting markets, Justin Wolfers recently wrote in the New York Times;their odds come to represent a quantifiable assessment of the conventional wisdom. Professor Leighton Vaughan Williams, of the Political Forecasting Unit at Nottingham Business School wrote; The power of the betting markets to assimilate the collective knowledge and wisdom of those willing to back their judgement with money has only increased in recent years as the volume of money wagered has risen dramatically.
There is only one problem with this notion of conventional wisdom enshrined in a super smart betting market - the betting market does not always act smart. Trump was right - nobody saw him coming. On the 7th of July 2015 the implied probability on Betfair of Donald Trump becoming President was 4%. When betting opened on the next Labour Party Leader after the departure of Ed Miliband, Jeremy Corbyn was not even quoted in the betting. When he did enter the betting he was quoted at 100/1 and he was friendless in the market.
2016 U.S. Election Implied Probabilities.
Source: Bettingmarket.Com analysis. 07/07/2015.
Next Labour Leader Implied Probabilities
Gloria De Piero
Source: Bettingmarket.Com analysis. 08/05/2015.
When betting markets act irrationally, the so-called experts will always find an explanantion as to why something other than what they have predicted has occured; although strangely, the explanation never comes to light until after the event! Self proclaimed Bremain supporter Leighton Vaughan Williams, famously dismissed the collective intelligence of the 17.4m people that voted for Brexit with an artcle declaring that it was the Sun and Mail wot won it. Oh, if only he had shared this wisdom with his devoted Twitter followers before the vote had taken place. This of course ties in neatly with Tetlock's assertion that experts rarely
if ever admit that they are wrong, and that when they are forced to admit that they were, they are always at hand with a large collection of excuses; timing, an unforseen event had occured, or, they had been wrong but for the right reasons. (the I knew it all along or hindsight bias, sometimes translated as I was simply too clever by half for my own good.)
The betting market arbitrageur is the one punter that is never left holding the baby; he has left the room before the first squeal breaks out. He has won regardless of the outcome. He has surfed the wave of delusion, and parked up his surfboard, long before the tsunami has hit the shore. He and he alone, knows that an enhanced illusion led people to become unrealistically bullish and that a majority of traders are simply prone to herding and over and under-reacting to breaking news and dislay a strong collective confirmation bias.
When we look back at the Brexit vote, the key question that we must ask ourselves, is just why it was that betting and
financial markets diverged so significantly from the polls (as per the folowing chart from Bloomberg).
A further mysterious aspect of the entire episode was the news that hedge funds had received private exit polls
prior to the close of the polls, telling them that the UK had voted in favour of Brexit. They had traded on this information and
made hundreds of millions, but such was the weight of the mug money supporting Remain in both the betting and FX markets that
their trades were able to seemingly pass under the radar. The market failed to respond to the presence of insider information.
The polling average missed the final outcome by around only 4%, and as the following table demonstrates, five of the eleven polls
at the close of voting actually had leave winning. They were simply ignored by a majority of those trading in the betting market.
A significant aspect of the narrative fallacy put forward by those that opposed Brexit, was, that given that a majority of the polls that came out in favour of Brexit were online polls, they had to be wrong - people, it was contended, were seemingly more likely to reveal their true voting intention when contacted by telephone (paradoxical logic par excellence).
Throughout the Brexit Referendum campaign a narrative fallacy took hold amongst a majority of betting market participants; betting market discipline had allegedly harnessed the wisdom of the crowd, who for some reason (perhaps only best known to them, or to the people that like to speak of prediction markets) were allegedly in receipt of some special causal insight that was not available to the pollsters, or indeed to anybody else for that matter; betting market participants believed that they were receiving information that was somehow privileged, or at least extremely insightful and from this they were able to construct a coherent story in which the implied probability suggested by the betting market actually made sense (In another context such behaviour might be labelled schizophrenic). This was confirmation bias and motivated reasoning at its finest. Most traders believe themselves to be less prone to biases than other traders - otherwise why would they bother to trade.
The tendency of people to employ memory bias to construct self-serving narratives of the past was also in evidence. The recent result of the Scottish Referendum served to feed the delusion and crystalise the viewpoint that when it came to the actual Brexit vote people would choose to vote in relation to their best interests
(as defined by the traders) (recency bias and availability heuristic at work). Such a belief highlights the risk of mistaking what’s happened in the recent past for some sort of iron law, and ties in neatly with Kahneman's assertion
that Any recent salient event is a candidate to become the kernel of a causative narrative....The core of the illusion is that we believe we understand the past, which implies that the future should also be knowable, but in fact we understand the past less than we belive we do.
There was also of course significant anchoring at work. If the betting market says that an event has an implied probability of 90% or more, then people are going to be strongly influenced by this number (the somebody must know something bias). Big probabilities breed isomorphism - birds of a feather fock together. Few, despite their best efforts manage to escape from the ubiquitous character of the anchoring bias. Anchors act as unconscious cues and influence information processing that biases judgments toward the anchors, whilst also serving to feed the notion that conformity of opinon makes something more likely to be right. It has been clearly demonstrated that people's subjective interpretation of probabilities is affected by the extent to which they want the actual event to occur. Most people, incorrectly view something with a probability of 70% as a near certainty and act accordingly.
When reviewing just why it was that the betting markets performed so poorly when it came to adjusting to new information, contrary to Bayes' rule, one would do well to remember that Tetlock found that people who spend their time and earn their living, studying a particular topic, produce poorer predictions than dart throwing monkeys. In Expert Political Opinion Tetlock found that the average expert's predictions were no better than a random guess; moreover, he also found that there is something about being a high ranking expert that interferes with forecasting. Human affairs are mostly random and intractable (and often the product of luck): even Tetlock's superforecasters got Brexit and Trump wrong.
Kanheman notes that errors of prediction are inevitable because the world is unpredictable. Secondly,
he states that high subjective confidence is not to be trusted. Thirdly, it is unlikely that lessons will be learnt, because facts that threaten livelihood and self-esteem are very very quickly forgotten. Kanheman notes
People can maintain an unshakable faith in any proposition, when they are sustained by a community of like-minded believers.
In what was surely one of the greater ironies of the entire EU Referendum betting market campaign, Mike Smithson, who is regularly quoted in the media as being a betting guru, tweeted that things looked good for Bremain as far as market on Betfair was concerned, but that he had no idea what this actually meant!! Whilst Smithson may well have saved face with this comment, it was hardly a ringing endorsement for his beloved political betting markets.
In the run up to the 2016 U.S. Presidential Election Professor Leighton Vaughan Williams took to Twitter to tweet to Nate Silver about the supremacy of the betting markets.
Bryan Cranston, an online lecturer in politics, and PhD candidate at Swinburne University, Australia, rose to fame after penning an article in the UK's Independent online newspaper under the heading Can Donald Trump win the election? Here’s the mathematical reason why it’s impossible for him to become President. It seemed that the traders on Betfair believed Cranston, for at one point during the evening of election day, the implied probability that Clinton would become the next U.S. President was 88%.
In betting on individual States, the traders on Betfair had Clinton nailed on in Florida, Michigan, Pennsylvania and Wisconsin.
She lost them all to Trump.
To give the polls their due, two of them, IBD/TIPP and USC Dornsife/LA Times, showed victories for Trump, but failed to predict that Clinton would win the popular vote. All of the other major polling outlets, and the great Nate Silver, showed at least a 3-4 point national lead for Hillary Clinton.
When we first visited the French Presidential Election Betting Market in July 2016, Alain Juppe was the warm favourite
in the betting market, with an implied probability of 36%.
Source: Bettingmarket.Com analysis. 25/07/2016.
On the 7 November 2016, the implied probability that Juppe would be French
president had climbed to 68%.
Source: Bettingmarket.Com analysis. 07/11/2016.
Spring forward to 30 November 2016 and Juppe has gone, replaced at the top of the market by Francois Fillon,
who back in July was a 100/1 shot in places (an implied probability of 1%).
FRENCH ELECTION - NEXT PRESIDENT
Marine Le Pen
Source: Bettingmarket.Com analysis. 30/11/2016.
In the run up to the first round vote, which took place on Sunday 30 April 2017,
Macron, who the betting market had failed to spot, consolidated his overall lead in the Betfair French Presidential election betting market, with Le Pen moving back into second place. The Melenchon
bubble had been well and truly popped. However, in betting on who would win the First Round vote, Betfair
traders had well and truly nailed their colours to the Le Pen mast, affording a Le Pen victory in the First Round vote a 60% probability.
When the results were announced, Macron had in fact won the first round vote, with a 24% share, against a 21.3% share for Le Pen.
Once again the so called wisdom of the crowd was found wanting.
Betfair Exchange: To win The First Round
Source: Betfair. 30/04/2017.
The Richmond Park by-election was a UK parliamentary by-election in the constituency of Richmond Park, held on 1 December 2016.
The Polls had Zac Goldsmith, an independent candidate and anti-Heathrow campaigner, as the clear front runner (see below). As the polls
closed, the implied probability in the betting market that Goldsmith would win the seat was 68% - he duly lost.
Presidential elections were held in Austria on 4 December 2016. Almost without exception the Polls had Norbert Hofer of the Freedom Party of Austria in the lead. On the morning of the contest the implied probability that Hofer would be the next president of Austria
was 73% - he duly lost.
Opinion polling for the Austrian presidential election, 2016
Van Der Bellen
The 2017 UK General Election represented another significant blow for the so-called prediction markets. On the eve of the poll, the implied probability of a Conservative majority on Betfair was 87%. The betting market also suggested a Conservative majority of between 75-99 seats.
The 2017 General Election actually resulted in a hung parliament, with no party able to win a majority of the 650 seats in the House of Commons. The Conservative Party made a net loss of 13 seats.
As regards the polls, in their final published poll ICM put the Tories on 45%, a 11% lead on Labour. ComRes predicted the Tories would score 44% and achieve a 10-point lead over Labour, whilst BMG Research put the Conservatives on 46% and achieving a 13% lead over Labour. YouGov put the Tories seven points clear of Labour as did Opinium. The prize went to Survation who put the Conservatives on 42% and Labour on 40%, very close to the actual result. Their poll was simply ignored by the traders in the betting market, even though recent events had clearly suggested that polling companies were actively engaged in statistical smoothing and herding.
The 2019 federal election in Australia represented a further failure for both the polls and betting markets. On the eve of the election
YouGov/Galaxy, Ipsos and ReachTEL polls had Labor ahead 51-49 on the two-party preferred vote. The average implied probability of a Labour victory
with the bookmakers was 82%. One punter lost $1MILLION on Labor, whlst another lost $850,000. Australian online sports betting operator Sportsbet, owned by Flutter Entertainment, paid out AU$1.3m to bettors who’d backed Labor to win before the result was called, based on the company’s assertion that 70% of its election wagers were on Labor and "punters rarely get it wrong on elections."
Fully rational traders in efficient markets should not react with delay, and when and where they do their mistakes and their cognitive biases should be
ironed out by the disciplining presence of arbitage. In their article "The behaviour of betting and currency markets on the night of the EU referendum" Linton and Auld
found that - " The betting market took 2 hours to reflect the information contained in the vote whereas the currency market took over 3 hours. There was a close to risk-free arbitrage opportunity in the two markets. The arbitrage result suggests that a violation of EMH in the weak form has occurred. "
And this still happened despite the fact that a number of hedge funds actually knew that the UK had voted to leave the EU before anybody else.
People still confuse the likes of horse racing betting markets - predictive - with political betting markets - not predictive. They drink the Kool Aid - cheer when the political betting market favourite wins, and acclaim that the betting market has harnessed the wisdoms of crowds. Political betting markets are not horse racing betting markets - there is no form to go on, where insiders exist they are crowded out in a sea of mug money, there is very clear evidence that all known information is not aggregated and assimilated in to the closing price and as Mutalik said: "Aside from potential clues gleaned from a fluke result, it would take hundreds of U.S. presidential elections to definitely conclude that one election forecasting model is superior to another." The phenomenon is far too complex and chaotic to be modelled with any great precision; every election has its own one-off contingencies and indetermination, deviation, non-linearity and endless feedback loops are the order of the day for those seeking to model them. There is never enough informational structure in the environment to allow precise predictions to be made, as Sam Wang so ably demonstrated with his infamous predictions on Clinton.
There is little doubt that we have now come through a period during which people simply had an over-heightened expectation of what it was that political betting/prediction markets could and would deliver. In general, and certainly in relation to the two biggest and most liquid events of recent times - Trump and Brexit - observed trader behaviour in these political betting markets deviated starkly from prediction market model expectations. Bayes' rule, which holds that rational agents will always update their beliefs on receipt of new information was simply not followed. More often than not, traders were seen to be swayed by unconscious cues in the environment and to be prone to every cognitive bias in the book - evidenced by continual displays of herding; over and under-reaction to breaking news and strong evidence of a collective confirmation bias at work, whereby a majority of traders selectively sampled information in order to support their own preordained hypotheses. (In the wake of the Brexit vote one FX trader told the author; None of us knew anybody that voted to leave.).
The likes of Hanson and Wolfers fostered an essentialist mode of thinking that reframed betting markets as prediction markets in the process ascribing to them a truth seeking power that they simply did not have. The shocking performance of these markets vis a vis Trump and Brexit - where they failed to follow Bayes' rule -
clearly demonstrated how easily essentalist thinking can very easily lead to mistaken predictions about future outcomes.
Looking forward to the 2019 UK General Election, and there are many people who believe that traders in the FX space are strategically
manipulating the Overall Majority Betting Market on Betfair. They aren't. The political betting market on BETFAIR as to which party will obtain an overall majority is simply tracking the poll of polls and that is currently telling us that Tories have a 9-10 point lead and are on track to achieve an overall majority. No more nor less. If the polls call it correctly this time, the betting market will simply follow suit. No magic.
As arbitrageurs it is our job to strategically manipulate human biases - not least the astonishingly idiotic notion that punters rarely get it wrong on elections. See you on the other side of the trade.
1. Herding or herd behaviour represents the tendency for an individual to follow the actions of a group, whether those actions are rational or irrational (out of fear of being alone or missing out).
2. Confirmation bias is the tendency to search for, interpret, favour, and recall information in a way that confirms one's pre-existing beliefs or hypotheses.