There are several fundamental problems with prediction markets:
1) Every market participant is not a savvy investor. InTrade was notorious for political bias and emotional trading (check out the comment section). The idea is that a true insider will place a large bet that provides valuable information to the market. This is rarely the case. Most of the people bet based on what they want to happen rather than what they know will happen. [1] This problem is compounded by the fact that most of the bets on intrade in particular were rather small, hundreds of dollars. People tend to speak more accurately with their wallets as opposed to their mouths, but only with significant amounts of money on the line.
2) The markets themselves are never large enough. The system doesn't work unless the people that place big bets are experts or insiders. The majority of people aren't familiar with the concept of prediction markets, much less any particular sites. One of the best cases for an information market would be someone who works on a political campaign placing a big bet for or against their candidate based on inside knowledge. But something like this can't happen until the average political staffer has heard of a prediction market site, which we are still a long way away from.
3) The best way to make money from a market is to out think the other participants. Accurately calculating prices based on the current supply and demand situation works too, but it's slower and more difficult. Instead of asking "Who do I think will be elected president?" people might themselves "Who do the other participants think will be elected president?" This leads to a functioning market but it doesn't do much for the goal of aggregating knowledge to make accurate predictions.
I like the concept of prediction markets because I love the idea of utilizing collective intelligence. But I'm constantly disappointed by the implementations that I see. It's a very tricky thing to do but I think that whoever finally figures it out will have built something valuable for all of us.
1) The presence of non-savvy participants should encourage users, after all it means that there is money to be made! If the only users were insider traders, you'd be mad to join in.
2) Betfair had US election markets with hundreds of thousands of dollars at stake, and this is a site that blocks US users. So the interest and the money is there. (The legal/political problems in many countries are still a big hurdle though) Admittedly, the volumes are still peanuts compared to most sports markets...
3) Not really true. You win a bet if you get the result right, e.g. You predict the result of an event. You don't win by guessing the beliefs of others. Sure, you can trade in and out of a market as opinion changes, but you are still betting on a result and not an opinion.
"The idea is that a true insider will place a large bet that provides valuable information to the market."
Yes, and in practice, the true insider has every incentive to provide false information to the market, so as to manipulate people's expectations. The insider seeks alpha by trading on the resultant volatility in that prediction's pricing.
Let's imagine I am the perfect insider. I have a crystal ball that somehow gives me 100% flawless predictive ability into the outcome of a particular bet (say, the next Republican primary). I could make a fair amount of money by betting on the winner, or I could make a lot more money by manipulating the information in the marketplace, creating volatility in the prices of the prediction bets, capitalizing on each fluctuation, while still holding some inventory in the correct outcome. If I knew the winner was going to be Joe Blow, I could bottom out Joe Blow's price by seeding false information, buy him low, then do the same for other candidates.
Of course, the real world doesn't have perfectly predictive crystal balls. But because prediction markets are too small to cause real-world changes (i.e., there's no observer effect), manipulating information would not have a demonstrable effect on outcomes (as it would in a larger, more efficient marketplace). Ergo, as the insider with better info than most, my incentive is to mislead. I do not need a crystal ball to make a killing; I just need slightly better information than the rest of the market. The smaller the market, the more likely it is that my inside information is better than the market's.
In a much bigger market, I couldn't get away with this strategy. At least not very easily or reliably. My seeding misinformation about Joe Blow would actually hurt Joe Blow's fundraising ability, thereby creating a self-fulfilling prophecy, thereby causing the market price to more accurately reflect reality. If I massively short Joe Blow, Joe Blow's chances actually drop. I'd get less alpha. But as you've said, the markets are way too closed and small to exhibit such an effect -- so I can rig the game accordingly.
One added wrinkle is that some people may have a positive incentive to make inaccurate bets, if they have something riding on the perception of the outcome, that's sufficiently important to them to be worth spending the money pumping up the perception. Whether that's feasible depends on the size of the market, but if InTrade drives even some of the news cycle, and if $100k can move the InTrade needle on a relevant issue, then blowing $100k on it is essentially advertising spend, an attempt at image-boosting.
Your initial thesis is not supported by your observations, which anyway are problematic.
(1) This is not a "fundamental problem." Not every participant in the NYSE is a savvy investor, either.
(2) This was also true of the automobile market. It didn't stop Henry Ford. This is a serious incidental problem, but not a fundamental one.
(3) The best way to make money in a prediction market is to be able to predict the outcome of the predictions. You can also try to do what you're suggesting, and may have some success. Anyway, the evidence is that prediction markets work, both for hedging and for knowledge prediction.
All very good points. I had worked some years ago on a prediction market site which attempted to merge 3 mechanisms for gaining collective intelligence: Polling, paramutual betting, and full buy/sell market. It was motived by the fact that full blown market simulations are a steep learning curve for the non-investor, but that person has a valuable opinion nonetheless. Never did much with it.
Considering that I upvote pretty much every gwern.net article I see (the guy rarely disappoints) and that there's probably a fairly cohesive Overcoming Bias/Less Wrong demographic doing the same, how long will it take before we're banned as a voting ring?
If I'm right about the HN readership, gwern.net articles are going to receive upvotes from a much larger population than just the intersection of HN and LessWrong. Furthermore, if there is cohesion with respect to gwern's stuff, then that cohesion would either disappear when it comes to other submitters (if it's simply tribal allegiance) or we'd see it with other articles of interest (if it's based on shared interests).
If the cohesion disappears with other submitters, then any voting ring detection would have to be overly sensitive to pick up on your love of gwern. We'd hear about a lot of false positives.
If the cohesion is strong enough to warrant mention and it persists across other domains, then you'd probably see some trouble even without gwern.net submissions.
There was a prediction markets company that YC funded in its second-ever batch: Inkling Markets. (http://inklingmarkets.com) It's still going, from what I understand through enterprise sales.
Also, for those of you that haven't heard Intrade is shut down and going through some complicated legal proceedings. Their former founder/CEO died climbing Mount Everest a couple of years ago, and I don't think the company ever fully recovered.
(I used to do a lot of work in prediction markets.)
Not just that, their financial situation suddenly became 'murky' and they shut up shop without letting customers withdraw their balances. As I understand, it is still unclear whether or not they have the cash to pay back everyone yet.
I'd never really heard of prediction markets before this post. Does anyone know the reason prediction markets are legal but other forms of online gambling such as poker are not?
I worked for a company that tried to sell prediction markets (we worked on the Policy Analysis Market, if anyone remembers that debacle), and the legality is one of the biggest sticking points.
It was pretty easy to sell the idea, but invariably once the contract landed in the legal department they'd put the brakes on, and we'd have to do some contortions involving play money that gets converted to real money and so forth. Once you start taking the real money out of the equation the results are a bit more suspect.
Nevertheless we did manage to convince a major media company, a couple large pharma companies, and an advertising company to set up some small scale prediction markets.
From Wikipedia:
Because online gambling is outlawed in the United States through federal laws and many state laws as well, most prediction markets that target U.S. users operate with "play money" rather than "real money": they are free to play (no purchase necessary) and usually offer prizes to the best traders as incentives to participate. Notable exceptions are Intrade/TradeSports, which escapes U.S. legal restrictions by operating from Dublin, Ireland, where gambling is legal and regulated, and the Iowa Electronic Markets, which operates from the University of Iowa under the cover of a no-action letter from the Commodity Futures Trading Commission and allows bets up to $500.
They aren't legal in the US generally. A few like the Iowa Electronic Market have a special exemption and very low upper limits on spending. Others like Betfair and Intrade when it existed are hosted in other countries, e.g. Ireland.
Also, do people try to influence the outcome itself? For example, couldn't you ask: "When will X person die." And then someone could bet a huge amount of money on it, and then go kill that person?
This is a good article. However if anyone is interested in following it, they should know that when there are multiple bets available, the simple Kelly criterion falls apart.
See http://www.elem.com/~btilly/kelly-criterion/ for a much fuller explanation of the result, and why it is true. (I keep meaning to automatically optimize the multiple bet version of it.)
Good link. I was writing a reply to make a couple of points but the page says it best:
"Many people will tell you to bet less than the Kelly formula says to bet. Two reasons are generally given for this. The first is that gamblers tend to overestimate their odds of winning and so will naturally overbet. Betting less than the Kelly amount corrects for this. The other is that the Kelly formula leads to extreme volatility, and you should underbet to limit the chance of being badly down for unacceptably long stretches."
The volatility is huge; you have a 50% chance of losing half your bank over time even if you bet correctly. Not many people can cope with those spikes in gains and losses!
Now imagine prediction markets with the twist proposed by Jim Bell: everybody bets on a day a person will die. If that day passes or the person dies before, you lose the money to those who predicted the right day.
Now who can know for sure when somebody dies? Exactly.
Frankly I'm amazed something like this hasn't taken off on the deep web yet. Tor + Bitcoin should do it.
Tangential, but I took a class with one of the professors in the linked paper (Sethi). It was a great class - many of the homeworks and exam questions were based around Intrade. (We didn't trade any actual money, but it really helped to illustrate the concepts of financial economics, which can get very abstract).
There were investigations of money laundering after the most recent presidential election. They ran into problems letting people from the USA make predictions. I think they are on their way out, they are basically gone already. Sad, since I loved going there!
Hey, I've created a site for making/tracking predictions called The Red Book (http://rdbk.net/). It's simple, just Will/Won't votes on predictions with a little gamification added to encourage community involvement. Just thought I'd plug it here if anyone is interested.
If you are interested in prediction market type betting and got friends who like the same, you might like http://www.bespokebets.com which lets you setup your own market easily and for free (play-money - and yes talking my book)
nice article, but I don't use the same strategy as you describe...
I was looking at prediction market recently, and tried a few free-to-play websites such as Inkling. I ended up on swissnoise (http://go.swissnoise.ch). They use virtual money for trade, but with real-money prizes which is very nice! Plus I have the feeling of helping research in this field (it's developed by some university).
Since your not really investing in anything, prediction markets are like gambling. You might as well bet on sports games.
As for their utility, the predictions are about as accurate as any other prediction, which is usually completely worthless. Might work ok for the boring stuff, but show me evidence that prediction markets can forecast the next 9/11, the next iPhone, or the next Arab Spring.
But you are investing with something, namely your own money, and it is this that gives the prediction markets value. Anyone can shout out their silly predictions, but if they have to back them up with cash, then the predictions tend to get better. The article has a quote that sums it up well:
"The usual touchstone of whether what someone asserts is mere persuasion or at least a subjective conviction, i.e., firm belief, is betting. Often someone pronounces his propositions with such confident and inflexible defiance that he seems to have entirely laid aside all concern for error. A bet disconcerts him. Sometimes he reveals that he is persuaded enough for one ducat but not for ten. For he would happily bet one, but at 10 he suddenly becomes aware of what he had not previously noticed, namely that it is quite possible that he has erred."
If there is a better method for prediction, and a prediction market exists, you can arbitrage the difference to make money and bring accuracy to the market.
> As for their utility, the predictions are about as accurate as any other prediction, which is usually completely worthless. Might work ok for the boring stuff, but show me evidence that prediction markets can forecast the next 9/11, the next iPhone, or the next Arab Spring.
See the IARPA geopolitical prediction contest, on exactly that sort of topic. I am an active participant in the GJP prediction market ( http://www.gwern.net/Prediction%20markets#iarpa-the-good-jud... ). The contest is not yet over, but there's already clear rankings of skill (contrary to what you say,most people cannot predict worth a damn) and IIRC, IARPA has said that the aggregate predictions from GJP & DAGGRE (more prediction markets) are better than its existing experts.
Well, part of the point is that by predicting, you get better at predicting! And the utility there is getting better at recognizing biases and being a more rational human being, which pays dividends in all sorts of aspects of life.
[+] [-] hooande|12 years ago|reply
1) Every market participant is not a savvy investor. InTrade was notorious for political bias and emotional trading (check out the comment section). The idea is that a true insider will place a large bet that provides valuable information to the market. This is rarely the case. Most of the people bet based on what they want to happen rather than what they know will happen. [1] This problem is compounded by the fact that most of the bets on intrade in particular were rather small, hundreds of dollars. People tend to speak more accurately with their wallets as opposed to their mouths, but only with significant amounts of money on the line.
2) The markets themselves are never large enough. The system doesn't work unless the people that place big bets are experts or insiders. The majority of people aren't familiar with the concept of prediction markets, much less any particular sites. One of the best cases for an information market would be someone who works on a political campaign placing a big bet for or against their candidate based on inside knowledge. But something like this can't happen until the average political staffer has heard of a prediction market site, which we are still a long way away from.
3) The best way to make money from a market is to out think the other participants. Accurately calculating prices based on the current supply and demand situation works too, but it's slower and more difficult. Instead of asking "Who do I think will be elected president?" people might themselves "Who do the other participants think will be elected president?" This leads to a functioning market but it doesn't do much for the goal of aggregating knowledge to make accurate predictions.
I like the concept of prediction markets because I love the idea of utilizing collective intelligence. But I'm constantly disappointed by the implementations that I see. It's a very tricky thing to do but I think that whoever finally figures it out will have built something valuable for all of us.
[1] http://go.bloomberg.com/political-capital/2012-06-29/intrade...
[+] [-] joosters|12 years ago|reply
2) Betfair had US election markets with hundreds of thousands of dollars at stake, and this is a site that blocks US users. So the interest and the money is there. (The legal/political problems in many countries are still a big hurdle though) Admittedly, the volumes are still peanuts compared to most sports markets...
3) Not really true. You win a bet if you get the result right, e.g. You predict the result of an event. You don't win by guessing the beliefs of others. Sure, you can trade in and out of a market as opinion changes, but you are still betting on a result and not an opinion.
[+] [-] jonnathanson|12 years ago|reply
"The idea is that a true insider will place a large bet that provides valuable information to the market."
Yes, and in practice, the true insider has every incentive to provide false information to the market, so as to manipulate people's expectations. The insider seeks alpha by trading on the resultant volatility in that prediction's pricing.
Let's imagine I am the perfect insider. I have a crystal ball that somehow gives me 100% flawless predictive ability into the outcome of a particular bet (say, the next Republican primary). I could make a fair amount of money by betting on the winner, or I could make a lot more money by manipulating the information in the marketplace, creating volatility in the prices of the prediction bets, capitalizing on each fluctuation, while still holding some inventory in the correct outcome. If I knew the winner was going to be Joe Blow, I could bottom out Joe Blow's price by seeding false information, buy him low, then do the same for other candidates.
Of course, the real world doesn't have perfectly predictive crystal balls. But because prediction markets are too small to cause real-world changes (i.e., there's no observer effect), manipulating information would not have a demonstrable effect on outcomes (as it would in a larger, more efficient marketplace). Ergo, as the insider with better info than most, my incentive is to mislead. I do not need a crystal ball to make a killing; I just need slightly better information than the rest of the market. The smaller the market, the more likely it is that my inside information is better than the market's.
In a much bigger market, I couldn't get away with this strategy. At least not very easily or reliably. My seeding misinformation about Joe Blow would actually hurt Joe Blow's fundraising ability, thereby creating a self-fulfilling prophecy, thereby causing the market price to more accurately reflect reality. If I massively short Joe Blow, Joe Blow's chances actually drop. I'd get less alpha. But as you've said, the markets are way too closed and small to exhibit such an effect -- so I can rig the game accordingly.
[+] [-] _delirium|12 years ago|reply
[+] [-] javert|12 years ago|reply
(1) This is not a "fundamental problem." Not every participant in the NYSE is a savvy investor, either.
(2) This was also true of the automobile market. It didn't stop Henry Ford. This is a serious incidental problem, but not a fundamental one.
(3) The best way to make money in a prediction market is to be able to predict the outcome of the predictions. You can also try to do what you're suggesting, and may have some success. Anyway, the evidence is that prediction markets work, both for hedging and for knowledge prediction.
[+] [-] l1ghtm4n|12 years ago|reply
[+] [-] spindritf|12 years ago|reply
(Anyone selling futures for that?)
[+] [-] presidentender|12 years ago|reply
If the cohesion disappears with other submitters, then any voting ring detection would have to be overly sensitive to pick up on your love of gwern. We'd hear about a lot of false positives.
If the cohesion is strong enough to warrant mention and it persists across other domains, then you'd probably see some trouble even without gwern.net submissions.
[+] [-] sker|12 years ago|reply
[+] [-] chm|12 years ago|reply
If you just upvote without bothering to learn what the article is about, then I think it beats the point of the voting mechanism.
Otherwise, there should be no problem, no?
[+] [-] jedc|12 years ago|reply
Also, for those of you that haven't heard Intrade is shut down and going through some complicated legal proceedings. Their former founder/CEO died climbing Mount Everest a couple of years ago, and I don't think the company ever fully recovered.
(I used to do a lot of work in prediction markets.)
[+] [-] joosters|12 years ago|reply
[+] [-] Permit|12 years ago|reply
Edit: Apparently they've just recently started using real money at some prediction markets: http://en.wikipedia.org/wiki/Prediction_market#Legality
[+] [-] spindritf|12 years ago|reply
[1] http://www.overcomingbias.com/tag/prediction-markets (easily one of top 5 blogs on the Internet)
[2] http://hanson.gmu.edu/ideafutures.html
[3] http://hanson.gmu.edu/futarchy.html
[+] [-] dminor|12 years ago|reply
It was pretty easy to sell the idea, but invariably once the contract landed in the legal department they'd put the brakes on, and we'd have to do some contortions involving play money that gets converted to real money and so forth. Once you start taking the real money out of the equation the results are a bit more suspect.
Nevertheless we did manage to convince a major media company, a couple large pharma companies, and an advertising company to set up some small scale prediction markets.
[+] [-] arethuza|12 years ago|reply
That, of course, depends where you are - in some countries online gambling is completely legal.
[+] [-] wikiburner|12 years ago|reply
I believe the Fed's recent interest in them had something to do with Intrade closing down.
Here's a snippet from a forum thread that's relevant:
http://forums.randi.org/showthread.php?t=125104
From Wikipedia: Because online gambling is outlawed in the United States through federal laws and many state laws as well, most prediction markets that target U.S. users operate with "play money" rather than "real money": they are free to play (no purchase necessary) and usually offer prizes to the best traders as incentives to participate. Notable exceptions are Intrade/TradeSports, which escapes U.S. legal restrictions by operating from Dublin, Ireland, where gambling is legal and regulated, and the Iowa Electronic Markets, which operates from the University of Iowa under the cover of a no-action letter from the Commodity Futures Trading Commission and allows bets up to $500.
[+] [-] bo1024|12 years ago|reply
[+] [-] lifeformed|12 years ago|reply
[+] [-] jws|12 years ago|reply
[+] [-] btilly|12 years ago|reply
See http://www.elem.com/~btilly/kelly-criterion/ for a much fuller explanation of the result, and why it is true. (I keep meaning to automatically optimize the multiple bet version of it.)
[+] [-] joosters|12 years ago|reply
"Many people will tell you to bet less than the Kelly formula says to bet. Two reasons are generally given for this. The first is that gamblers tend to overestimate their odds of winning and so will naturally overbet. Betting less than the Kelly amount corrects for this. The other is that the Kelly formula leads to extreme volatility, and you should underbet to limit the chance of being badly down for unacceptably long stretches."
The volatility is huge; you have a 50% chance of losing half your bank over time even if you bet correctly. Not many people can cope with those spikes in gains and losses!
[+] [-] peterjancelis|12 years ago|reply
Now who can know for sure when somebody dies? Exactly.
Frankly I'm amazed something like this hasn't taken off on the deep web yet. Tor + Bitcoin should do it.
[1] http://en.wikipedia.org/wiki/Assassination_market [2] http://en.wikipedia.org/wiki/Jim_Bell
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[+] [-] laoheike|12 years ago|reply
I was looking at prediction market recently, and tried a few free-to-play websites such as Inkling. I ended up on swissnoise (http://go.swissnoise.ch). They use virtual money for trade, but with real-money prizes which is very nice! Plus I have the feeling of helping research in this field (it's developed by some university).
[+] [-] normloman|12 years ago|reply
As for their utility, the predictions are about as accurate as any other prediction, which is usually completely worthless. Might work ok for the boring stuff, but show me evidence that prediction markets can forecast the next 9/11, the next iPhone, or the next Arab Spring.
[+] [-] joosters|12 years ago|reply
"The usual touchstone of whether what someone asserts is mere persuasion or at least a subjective conviction, i.e., firm belief, is betting. Often someone pronounces his propositions with such confident and inflexible defiance that he seems to have entirely laid aside all concern for error. A bet disconcerts him. Sometimes he reveals that he is persuaded enough for one ducat but not for ten. For he would happily bet one, but at 10 he suddenly becomes aware of what he had not previously noticed, namely that it is quite possible that he has erred."
[+] [-] benmanns|12 years ago|reply
[+] [-] gwern|12 years ago|reply
See the IARPA geopolitical prediction contest, on exactly that sort of topic. I am an active participant in the GJP prediction market ( http://www.gwern.net/Prediction%20markets#iarpa-the-good-jud... ). The contest is not yet over, but there's already clear rankings of skill (contrary to what you say,most people cannot predict worth a damn) and IIRC, IARPA has said that the aggregate predictions from GJP & DAGGRE (more prediction markets) are better than its existing experts.
[+] [-] tunesmith|12 years ago|reply
[+] [-] hannibal5|12 years ago|reply
https://en.wikipedia.org/wiki/Nirvana_fallacy
[+] [-] JackFr|12 years ago|reply
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