Tuesday, November 11, 2008

Media Bias: Direction and Variance

Michael Seringhaus touches on an interesting point regarding media bias. In terms of politics, whatever long-term directional biases the media has, in the short run its "bias" is also towards more variance.

It should be clear to everyone that what is reported during campaigns is often fed to the media by the camps themselves. This doesn't just apply to facts and trial-balloons, but also arguments that are more editorial in nature. For one thing, this dynamic allows reporters to ingratiate themselves to the campaigns, who can rely on them periodically to push their respective talking points. In exchange, reporters get the occasional tip. The media can act like a double-agent in this respect, alternating directional bias from news-cycle to news-cycle, week to week.

Most importantly, this "variance" makes the contest seem closer and more exciting than it may be in reality, which encourages consumption of the news product. If you were watching the markets, this tendency manifested itself most obviously on the election night. Long after Intrade gave a 99% chance for an Obama victory, CNN announced him as the winner, predictably at 11pm EST on-the-dot.

Furthermore, it turns out that prediction market prices near 50% might inherently be more volatile. This is the argument of a new paper by Panos Ipeirotis and Nikolay Archak in which they introduce a model where prediction market volatility depends only on price and time to expiration, as summarized in the below chart. As a trader, I think I would rely more on historical volatility in most cases for a couple of reasons, but the model is intuitive and suggestive with respect to the "news product" idea.