The breaking news is that Professor Justin Wolfers (of the Wharton business school in Philadelphia) has responded to my unforeseeable attack and to the subsequent Mike Linksvayer’-s comment.
A quick response to Chris:
Let me clarify what I think the key puzzle is: the odds of either Democrats or Republicans are – literally – unchanged since the week before the 2004 election. It seems amazing to me that there has been *no news* that is relevant to the 2008 election.And I don’t really know which way it should have gone (I’m not yet calling ‘08 for the Dems). For instance, Bush winning in ‘04 provides the Republicans with an incumbency advantage. Countering that, the last two years have provided the Dems with an advantage in the midterms, which you might think could persist to ‘08. And the cast of possible candidates is also starting to take shape, and the absence of Warner, the rise of Barak, and the continuing dominance of both Hillary and McCain are all important factors that we didn’t know about two years ago. All of this is hard to reconcile with the odds remaining unchanged.
I[n] response to Mike’s point: he is exactly correct to emphasize the difficulty in discerning the direction of causation between election outcomes and economic outcomes. But that is precisely the point of my forthcoming QJE paper with Snowberg and Zitzewitz (available at: PDF).
In that paper (which is what I describe in the WSJ), we look at stock market reactions to what are clearly random (or exogenous) shocks to the expectations of Bush’s re-election – the leaked exit polls, and the subsequent vote count. These experiments allow us to draw inferences about how changes in electoral prospects drive economic outcomes.
The Abstract Of That Paper:
Partisan impacts on the economy: Evidence from prediction markets and close elections – by Erik Snowberg, Justin Wolfers and Eric Zitzewitz – (PDF) – 2006-03-XX
Analyses of the effects of election outcomes on the economy have been hampered by the problem that economic outcomes also influence elections. We sidestep these problems by analyzing movements in economic indicators caused by clearly exogenous changes in expectations about the likely winner during Election Day. Analyzing high frequency financial fluctuations following the release of flawed exit poll data on Election Day 2004, and then during the vote count, we find that markets anticipated higher equity prices, interest rates and oil prices and a stronger dollar under a Bush presidency than under Kerry. A similar Republican-Democrat differential was also observed for the 2000 Bush-Gore contest. Prediction market based analyses of all Presidential elections since 1880 also reveal a similar pattern of partisan impacts, suggesting that electing a Republican President raises equity valuations by 2 3 percent, and that since Reagan, Republican Presidents have tended to raise bond yields.