'Election Stock Market (ESM)' is explained in detail and with examples in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
Election stock markets refer to financial markets whose contracts track the predicted and actual outcome of national elections. They are also called election prediction markets. Investors who participate in such futures contract forms of exchanges invest real money, purchase and sell contracts which are listed, take on the risk of losing their invested funds, and make profits on their positions. Such ESMs work much like traditional futures exchanges and commodity exchanges that cover future time deliveries of livestock, grains, and precious metals.
The real function and mission of such Election stock markets lies in correctly predicting the outcome of a national or provincial election. It might aim to forecast the popular vote shares or numbers of seats which the political parties obtain in legislative or alternatively parliamentary elections. Those markets that are effective prove to be highly reliable at contemplating information even before it becomes available in opinion polls. Such polls often require a few days to do and compile. The various traders in such an exchange tend to put aside their personal bias politically as they have real financial incentive to correctly share their honest opinion.
There are two other purposes for these Election stock markets. Naturally they are intended as a means of teaching people about elections and futures markets. Besides this though, the professors and universities that run them also rely on them for useful research surrounding election forecasting and the behavior of the electorate.
There are two such universities which have run these Election stock markets for more than a decade in North America. The main one in the United States is the Iowa Electronic Markets, founded and run by the Tippie College of Business of the University of Iowa. This market focuses its efforts on tracking mainly the congressional and presidential elections.
The University of British Columbia and its Sauder School of Business runs the Canadian-based UBC Election Stock Market. UBC concentrates on both provincial and federal elections for Canada. Both operate as not for profit enterprises for the purpose of research. Because of this, neither of them charges trading fees or commissions for trades. They generally limit the investment amounts to a range of between five hundred U.S. dollars and one thousand Canadian dollars.
In the last few years, new prediction markets which are privately operated have appeared. These markets do assess commissions and fees to pay for their costs of operation and for profit. Some charge net profits’ commissions while others levy a per transaction fee. Among the commercial markets are The Washington Stock Exchange and Irish-based Intrade Prediction Markets. Each of these follows predictions for a wide-ranging series of geopolitical events. The commercially operated markets bring in significantly more volume and investment since they do not place arbitrary limits on an investors’ participation.
Two main payout concepts exist with these Election stock markets. In the first model, the system proves to be a winner takes all type of market. One winning contract will pay the promised full face value amount (commonly one dollar) while all others will be worth zero. A party winning a full majority or plurality or a yes or no referendum are examples of this structured scenario.
In the other model, there are partial payouts on a few contracts which result from the percentage proportions on a given result. This percentage will commonly be multiplied by the standard dollar to determine the proportional payout. Two typical examples of this are a popular vote market share and a percentage of seats result for a given political party. The payouts would be figured according to the popular vote percentage share for the party in question. Traders often make money by purchasing those contracts which they feel are undervalued or by selling others which they believe to be overvalued.