Theory: “impact on the crowds”

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Intrade allows people to bet on the election. Right now,Intrade gives Obama a 66% chance of winning vs. 33% for Romney. This is calledthe “wisdom of the crowds”. The idea is that if somebody has some privateinformation, they’ll profit it from that information by going to Intrade andbuying/selling shares, moving the price. Thus, the final price encapsulateseverything known about the election. Thus, according to this theory, the bestanybody knows about Obama winning the election is 66%. I use this theory in myprevious post.
But that idea isn’t entirely correct.

If you are among the 1% of top earners, an Obama victory almostcertainly means your taxes are going up even more. To compensate, you can dowhat’s known as a “hedge”. You buy shares on Intrade betting on an Obamavictory (even if you think it unlikely), so that if Obama wins, you can use the winnings to offset the extraamount you’ll have to pay on taxes.

The same is true of other Intrade bets on things like theweather. Instead of betting, you could be hedging on theoutcome. If bad weather will cause a crop loss, then buy Intrade shares bettingon bad weather.

Thus, Intrade doesn’t necessarily reflect the “wisdom of thecrowds”, but the “impact on the crowd”.

I suspect Intrade still reflects the “wisdom of the crowds”to some extent, because it’s volume is too low to hedge. I actually looked into this onthe last election. I wanted to hedge against Obama’s rise in taxes (whichturned out to be 8.9% for me), but I found the Intrade volume to be too low.Any realistic attempt at hedging would swing the price to the point it wasn’tworth it. Thus, the only people betting on Intrade are those betting for fun,not profit.