Those Spurious Presidential Futures

Thursday night's presidential debates offered substance, and were relatively light on rhetoric and theatrics. That represents an improvement over the style-heavy focus we've seen so far during this election year. It also diverged from the political futures exchanges, which have become the electoral crutch of too many financial pundits.

These exchanges have a host of weaknesses. They have a very small number of active participants. The dollar amount wagered is tiny. And upon close inspection, these markets have, at best, a mixed track record, but that shouldn't be a surprise as the liquid, cash-rich markets offer no better utility in predicting the futures. Simply put, investors who make financial decisions based on these "prediction markets" are stepping into potentially costly territory, even as they have become de rigeur among financial pundits discussing the election.

Prediction Mechanism

Consider the following concepts as part of the basic beliefs of those who think futures markets can be used as predictors:

Price contains all the information one needs.

Human beings are rational economic players.

Information distribution is highly efficient.

Market participants capitalize on that information.

Markets are free from manipulation.

It's apparent to me, and to most market observers, that each of the above items is, at best, only partially true: Investors are hardly unemotional. The markets may be efficient eventually, but they often contain pockets of bad or poorly disseminated information. And while it may be difficult to manipulate the giant U.S. equities markets, the futures diminutive exchanges are much more easily disrupted.

Prediction vs. Discounting

Let's address the underlying notion supporting these exchanges, which is that a financial market has predictive powers. The faith in the forecasting power of the massive U.S. markets rests in large part upon the enormous dollar amounts involved. These huge markets greatly incentivize the "best and brightest" participants to dig up all they can in order to obtain a competitive advantage in anticipating the future direction of companies and indices. The capital markets are a relentless Darwinian jungle: With literally trillions of dollars at stake, sharp research gets rewarded while bad judgment gets punished.

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Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm's portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries. At the time of publication, Ritholtz had no position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback and invites you to send it to [e-mail].