VP: Short the Faves

Justin Wolfers isn’t buying the conventional wisdom on the VP shortlists, and he has some advice for traders: short the favorites.

It’s not that any of the candidates are specifically objectionable, says Wolfers. In fact, he agrees that the markets have the candidates in the right order. It’s a combination of history and behavioral economics. History suggests that surprise picks are not infrequent (he cites recent examples Quayle, Cheney, Lieberman), while behavioral economics points to trader overconfidence:

Compare this history of surprises with the fact that markets believe that they have narrowed the Democratic and Republican shortlists to four candidates – and, in each case, there is a greater than 80 percent chance that this shortlist contains the eventual nominee. Given the psychological evidence that traders are often overconfident, I think there is good reason to take these quantitative assessments with a grain of salt.

In other words, the markets are giving “the field” outside of each party’s top four CW options less than a 20% chance of coming in for a win.

For Dems, “the field” is anyone not Kaine, Bayh, Sebelius or Biden. For Reps, it’s anyone besides Pawlenty, Romney, Ridge or Palin.

On the Republican side, Wolfers notes that there is much less trade volume but doesn't elaborate on the implications. While I find Jay Cost's thoughtful analysis today on the urgency of picking Romney intriguing and find myself agreeing with most of its elements, I've long believed the advantage in seeing Obama's whole ticket before having to pick his own running mate is a strategic freeroll McCain should not give away. While there is only one legitimate historical example of a VP bringing in a state his party wasn't likely to have won otherwise (Muskie in 1968), VPs do contribute to an overall impression and narrative that applies over the whole electorate. McCain's strategic edge in selecting last, plus the instant ability to snatch the media spotlight 12 hours after Obama gives his nomination speech, is a one-time precious trump card that outweighs an extra week or two of attack dog mode from the VP.

If McCain picks last, the futures markets for his running mate will be affected by whoever Obama picks. For example, Sarah Palin's rise or fall in the markets will vary with whether Obama picks a woman first. If Obama picks Sebelius, that ticket's overall impression is "Big Change" and McCain is not likely to go with Palin. But if Obama gives him the wedge demographic opening by picking a safe, bland white guy like Bayh, McCain may go for the longshot Palin to bite into the Democratic base - its customary edge with women voters.

For my own gut sense, I have never been comfortable with the conventional wisdom surrounding Obama’s VP pick. There’s something nagging about it, and no hard numbers to support my feeling. Perhaps it’s the “think different” approach to many aspects of the campaign – the next-level social networking, the unprecedented 50-state massive organizer approach, the generalized no-leak culture among decision-makers, etc. It strikes me that in multiple important key ways, the Obama campaign has made conscious departures from the conventional wisdom norm.

For example, I don’t know if Nate’s right about the Sebelius shell game with Tim Kaine, but one key takeaway from that post is that Obama’s is a campaign capable of playing chess and deftly hiding its hand. So the market judgment that there's less than a 20% chance of Obama pulling a VP surprise feels wrong, and I agree with Wolfers.

I don’t want to ride this point too hard, because Obama has certainly engaged in many standard strategies and made plenty of conventional decisions along the way.

I guess it depends on where the starting place for the VP decision is. Imagine the circumstances when a VP would actually have to fulfill his or her most important job description – serving out Obama’s term if he cannot finish it. What character traits would that individual need to possess to rise to the occasion in such a moment? I think a rational person like Obama would have started here. In fact, maybe this is one reason Caroline Kennedy is a key part of the search team.

But we don’t talk about that; we create incredibly strange theories such as picking Evan Bayh would send a coded signal to Clinton supporters that because Bayh supported Clinton, it’s a symbolic proxy for extending Clinton voters an olive branch and uniting the party, even if Obama doesn’t pick Clinton herself. Since my internal compass tells me we’re not starting what I sense is the right starting point, it’s been difficult for me to embrace the conventional discussions about A thus B thus C thus Obama will select X.

I freely admit I could be wrong. But when Wolfers refers to history’s frequent surprises and points to the market’s likely overestimation of frontrunner chances, I confess I’m already primed to be receptive to that argument.