PM Chart of the Day

Chart and quote from Volokh

Consider the figure below. It aggregates a total of 145,388 trades on Major League Baseball games in 2005. Each contract would pay off $10.00 if the specified team won the game.

The x-axis represents different transaction prices, and the y-axis shows, for all trades at that price or up to 10 cents higher, the probability that the team in fact won the game. Note that the points conform fairly closely to a 45-degree line.

This doesn't prove that prediction markets are perfect predictors....

Hubdub Debuts at DEMO 2008

The Digg of PMs has launched. Zdnet blog on the firm:

“Hubdub lets people follow news over time and get forecasts on how news stories turn out,” company co-founder Nigel Eccles told me.

Hubdub, founded in November last year and headquartered Edinburgh, UK, allows users to formulate questions–such as ‘Will Apple introduce a tablet PC?’ or ‘Who will win the Florida Republican primary?’–and the community wagers on predictions with Hubdub dollars.

Five Reasons the Prediction Market Critics Are Wrong.

New PM post excerpt below. Read the full post at Midasoracle

1. It really was an upset – As it has been pointed out elsewhere, the Clinton victory was a surprise to everyone....

2. Pundits/Critics are NOT traders...

3. PMs are not polls – This common mistake is exemplified by this quote from the Chicago Tribune, “The New Hampshire primary was a reminder that prediction markets, where bettors are putting money on the line, can have no more value than opinion polls, where participation costs nothing.” This critic missed the point and doesn’t realize he is comparing apples and oranges....

4. Regulations have hurt the accuracy and liquidity of PMs – The inconvenience of opening a trading account at Intrade has excluded many Americans from participating....

5. “Serious people who study or work with these markets are not in the ‘markets are magic’ camp” – Prediction markets are like other financial markets: fat tails, black swans, bubbles, “manipulations” etc. ...

Tennis Corruption in The NY Times

The NY Times has a follow-up article on the after effects of the tennis betting scandal for the pros. During the August match strange betting patterns alerted the authorities that something was amiss. BetFair ended up voiding all the bets on the match. Tennis pro Nikolay Davydenko is still being investigated according to this latest NY Times article on the scandal:

Kris Dent, an ATP spokesman, also acknowledged that a “highly subjective” list of 140 suspicious matches dating from 2002 had been compiled by a European bookmaker and provided to investigators.

“There is a clear risk to the sport because players are being approached,” Mr. Dent said. “We take this incredibly seriously.”

UPDATE: The NY Times got the chart wrong, see more info here: http://blog.hubdub.com/ Thanks Nigel for the heads-up.

New PM Site for Marketers - Predictify.com

Predictify allows any user to post a basic question for free, while premium questions cost $1 per response and come with detailed demographic data. Users are incentivized for accurate predictions with cash and status rewards. Uniquely with this site, accurate predictors are paid more for their responses that less accurate users.

The site is aimed at people who want to use the demographic data and is a unique take on an increasingly crowded PM field. Despite the sports contract section, Predictify won’t substitute for Tradesports just yet.

Are certain types of questions prohibited?

Yes. Predictify may not be used for securities replication, odds-making, betting, gambling, or wagering.

More information about the firm here.

Taiwan Prediction Markets Call Election

More accurate than the media polls which didn't even predict the winning candidate:

While media polls failed miserably in predicting the results of the Taipei and Kaohsiung mayoral elections, one group of academics and political soothsayers prophesied the outcome with stunning accuracy.

Their nearly dead-on predictions were no accident, they insist, nor were there any crystal balls involved.

Using an Online Trading Market to Predict Success - Entrepreneur Magazine

Very positive piece about PMs:

Stephen Marcus wanted to predict the success of a new business book his company was producing. So his company set up an online trading market where thousands of people purchased imaginary securities based on how well they thought the book would sell. When more than 85 percent of the market participants predicted that the book would rank among Amazon.com’s top 1,000 sellers, Marcus breathed a sigh of relief.

Based on the accuracy of previous prediction market forecasts, the president and co-founder of 35-person Shared Insights likes the chances for the new book, to be titled We Are Smarter Than Me. Standard forecasting tools, such as focus groups, involve much smaller numbers of opinions, while the prediction market aggregates thousands of opinions, notes Marcus, 42, whose Woburn, Massachusetts, company generates annual sales of more than $10 million helping corporations build online communities.
...
Now businesses are using them to foretell sales and profits, identify the most appealing product features, anticipate likely project completion dates and perform other prognostications. Eli Lilly, General Electric, Google, Microsoft, Pfizer and Yahoo! have all used prediction markets.

Austrian Influence on Prediction Markets

I just like this article because it quotes Hayek. From Cnet:

In a 1945 paper, the great Austrian economist F.A. Hayek described how prices set by a free market are really "a mechanism for communicating information" about the probability of future events.

...Hayek's insight showed that the results can be surprisingly accurate, as long as enough people are allowed to wager real money on the outcome.

Now, technology firms are using a modern twist on this idea, called prediction markets, as a way to save money, harness the distributed knowledge of their rank-and-file employees...

TradeSports Senate Race: Were the markets wrong?

The answer, unequivocally, is no.

The suggestion that Tradesports "missed" on the control of the Senate is based on a faulty understanding of probabilities. By Election Day, Senate control really came down to three close races, Virginia, Missouri, and Montana. A probability calculator shows that if the markets accurately gave each of those races about a 60% chance of going to the Democrat, then the odds that all three would go Democratic were only 22% (0.6 to the third power). Therefore, a rational person would choose the Democrat in the individual races, but would nonetheless choose the Republicans to retain control. After all, the Republicans needed only one of those three, while the Dems needed all three. Only if we posit that the Democrats had an 80% chance to win each race would Senate control have been even a 50-50 proposition.

The Death of Pundits

One of the yet to be realized benefits of prediction markets is that hopefully it will put many professional pundits out of business. These bores make a living constructing sound bites and being “controversial” and rank about a picometer above reality TV “stars” in terms of respectability. Think of professional wrestling in suits: Ohh that Ann Coulter isn’t she just soooo controversial?? And Al Franken, wow is he snarky!! He uses humor to really showing those stupid Bush lovers up!!! –You get the idea, its only theatre.

If the concerns of the people on every topic can be quantified what is there to discuss? People aren’t entitled to their own facts. The number is, what the number is and that should be the end of the discussion. The question of whether Democrats or Republicans control the House becomes moot when you can say with certainty that the data indicate that the Democrats have X percent chance based on all the information now available. [Of course if you believe in property rights, individual freedom, fiscal responsibility, sound money, and a smaller State the question of who controls Congress has been irrelevant for a while.]

Anyway, Forbes says this guy is the best of the best when it comes to following elections:

As far as race-by-race election forecasting goes, Cook and his friend Stuart Rothenberg, who publishes the rival Rothenberg Political Report, more or less have the market cornered.

"They created this industry, and there's really no one else in the same ballpark as the two of them...”
…
Cook has been forecasting a Democratic takeover of the House since early August. But he was beaten to the punch by Rothenberg, who predicted it back in July.

The TS GOP House control contract closed below 50 for the first time on May 15th.

Why WSX and not TradeSports?

Washington Post article on the Washington Stock Exchange. Why are they promoting a fake money exchange when real money ones exist?

The site uses the theory of prediction markets -- the higher the "stock price" of an event, the more likely it is to happen -- to try to accurately forecast outcomes. The Iowa Electronic Markets, another political prediction market that started in 1988, claims to be more accurate than the polls 75 percent of the time.

So who's going to win that tight Senate race in Virginia? At press time, WSX gave the edge to Republican incumbent George Allen, who was trading at $62.25, while Democratic challenger James Webb was at $54.98.

The Allen contract on TradeSports is now at 72 with Webb's at 30.

Wages of Sin- The New Yorker on the Hypocrisy of Gaming Ban

The difference between the lottery and other forms of gaming. Plus how gov't intervention stifles innovation:

Sports betting, by contrast, involves skill, and it is possible, although very difficult, to consistently win money on it. Sports bettors are closer to stock or commodities buyers than to people who buy lottery tickets. How much difference is there, after all, between betting on the future price of wheat (an activity banned in some states in the nineteenth century) and betting on the performance of a baseball team?

Furthermore, the ban on online betting is hindering the development of new markets that could predict far more important outcomes than that of the N.B.A. finals. In the past few years, a host of prediction markets, as they’re usually called, have appeared online, offering people the chance to speculate on subjects ranging from the box-office performance of Hollywood films to the outcome of Presidential elections and the spread of bird flu.

Insiders should not only be permitted to trade, they should be encouraged

Prediction Markets and Insider Trading from Bainbridge, my take below:

Banning traders with the best information does not benefit any of the market participants or the market itself. Most people would agree that insider participation ensures market pricing is accurate. Excluding their knowledge will cause the market to decrease in relevance since it couldn’t be relied on to aggregate all available information about an event. Even defining what constitutes an “insider” for news/event related contracts would be a bigger rules debacle than the NKM contract.

Traders don’t benefit from mispricings; a winning trade due to banning of knowledgeable participants sounds like luck or some kind of subsidy rather than skill. Decision markers will also suffer if the markets do not accurately reflect the odds of an event occurring. An academic might make the argument that liquidity would suffer if it was known that insiders were able to trade. However isn’t that already implicitly the case with every prediction market contract currently? Traders, so far, don’t care if there are insiders trading.

Defining an insider would be an impossible and silly task. Would a meteorologist be banned from trading weather contracts? After all they can use fancy modeling equipment and satellite data that most people wouldn’t be able to access. Being an insider is still no guarantee of a win. Even the ultimate insider on the NK missile contract, Kim Jong-il himself, would have lost if he longed the contract on TS. The exercise of defining an insider for most of the news contracts quickly turns absurd. Of course they shouldn’t be banned, they can’t even be defined! Does any knowledgeable market participant have an obligation to withhold information? Since it would be to their detriment to do so, who would benefit? It’s not the traders who are trading on off-prices. And it can’t be decision makers who are making decisions without using all the information that could be available.

The very idea that there is some special type of “insider knowledge” that shouldn’t be used for trading is an advancement of the idea of information socialism. There will always be parties with more information than the general public and those knowledgeable participants should be able to profit from their superior knowledge. What would be the point of acquiring it otherwise?

Free markets work. If demand exists for a market free of insiders than existing firms will profit from moving into that space. Any exchanges banning insiders would be a big step in the wrong direction.

TradeSports Won’t Reverse the NKM Contracts and They’re Right - The Trade is Settled

By now anyone who follows prediction markets is familiar with the TradeSports North Korea Missile contract debacle. Chris Masse did an excellent job covering and publicizing the case.

The Edmunds email rationally covers the reasons that TradeSports was wrong in expiring the contract at zero.

Several commentators on the incident wrongly suggest that TS should go back and compensate the traders of the contract. That would be a mistake. Refunding the bets after the fact won’t increase confidence in the market.

Time to Move On

Right or wrong, once a contract settles the question of who should win is a dead issue. Any clarification can’t take place after the trade is done. No trader wants a market that works that way. The fact TS provides the exchange and is not taking bets gives them a strong case to stick to their decision. Pushing for reforms (which TS has already put in place) is a good way to minimize expiry source confusion. Once traders know the rules and how contracts will be handled they will adjust.

This won’t be the last time that a contract is disputed on the exchange. What will hurt the market more than the current decision is if bets are reversed after settlement, turning the winners into losers. Traders won’t know when a contract really settles. It would also be a bad precedent for TS to hand out refunds to the bettors. Refunds now would taint any future contract disputes and cause inconsistency based on the size of the market. In other words, TS won’t be able to make refund larger volume contracts if there was a legitimate dispute. So the refund decisions would be related to volume not legitimacy, and that’s not a consistent way to run a market. The way to head that off now is by not giving refunds in the first place. TS has chosen a path and is obligated to stick to their guns.

No one (that I’m aware of) is suggesting that the contract winners’ trades be reversed and credited to the losers. Why should the funds to compensate the contract losers come out of TS’s pocket? If the contract really should have expired at 100, aren’t the current winners unjustly enriched?

TradeSports dropped the ball in the handling of this contract. Clarifying the rules for next dispute is what traders should focus on.

What counts for source confirmation? A press release? An anonymous source? A blog? A personal email? Recording of a phone call? What if the source won’t confirm either way?

Refunding traders who lost won’t fix the market or increase confidence of its participants.

New Market Blog

Not focused on Prediction Markets but this has some entertaining posts: http://thehedgefunder.blogspot.com/

CME Economic Derivatives Reception

-Gartman didn't say anything that Prediction Markets followers aren't familiar with. His overall theme was that putting money behind predictions will make them more accurate. He did share an amusing anecdote that he used the Iowa markets to get his election results info for his newletter and received many compliments for his “prescient” predictions.

-He also expressed surprise that this market has taken so long to get off the ground.

-How inside information will be handled: 1. CME rep said that the fact the market moves so much after fundamental releases is proof that the gov’t is good at keeping the number under wraps 2. If revealed early, an auction in progress would be halted but the previous ones would stand 3. If the number was revealed early but after the last auction it wouldn’t matter 4. If someone had inside info and wanted to use it the CME wouldn’t be where they would go

-The absolute number for consensus is not very important because it normally matches the Bloomberg/Reuters number. The CME advantage is that you can see the range and distribution of estimates and trade off of them.

-The auction ends 30 minutes before the number is released to give traders a chance to establish positions in other markets

-The trading has at least 120 trading firms participating

-The CME wants to expand to areas and releases that are the biggest market moves. They want to have contracts that are part of, “every day lives.”

International Prediction Markets - The Tradesports of India?

http://www.dnaindia.com/report.asp?NewsID=1026056&CatID=2

PublicGyan is an invite-only, general interest market started by Nitin Pai and Srijith Krishnan Nair. The site encourages members to determine the outcome of events by trading stocks using virtual currency or Moolers.

The site’s co-founders have cited the James Surowiecki book, The Wisdom of Crowds, as an inspiration, as it champions the cause of prediction markets.

Rummy, you're doing a heck of a job – Tradesports resignation contract shoots up

The pressure on Donald Rumfeld to resign is increasing. Several retired generals have openly criticized Rumsfeld which caused the RUMSFELD.RESIGN contract to gain this week.



The Cheney contract had slight gains as well this week and moved up in sympathy. As discussed here, the Cheney contract has more "outs" than the Rumsfeld one. This is due to the fact the contract can pay off if the current position is left for any reason, not just resignation.



The Bush admin must have learned its lesson from the Michael Browne incident, "The president believes Secretary Rumsfeld is doing a very fine job during a challenging period in our nation's history," is not nearly as catchy of a sound bite.

Take the movements with a grain of salt. Besides Larry Summers the market has not been extremely successful with predicting resignations so far.

Shiller Housing Hedges - CME Futures and Options

Seeking Cover if the Prices of Homes Fall

Expect to see many more articles like this when the contract become available for trading. The market is focused on metals now and the foreseeable future, but something like this gives prediction markets mainstream coverage. It may not all be positive writeups:

Many more constituencies would have reason to bet on a decline, however: mortgage lenders guarding against defaults and the prospect of holding foreclosed properties, builders concerned that their homes may fetch lower prices once they are on the market, as well as individual owners. Such lopsided interest could distort pricing, he warned, and furnish windfalls to professionals.

Once the market is established it should have the effect of helping prevent future bubbles. With a the futures contracts available, there is much less reason to buy the underlying if the purpose is speculation.

Time to hit the books: http://www.cme.com/trading/prd/env/housingres17858.html

American Idol Betting – Picking Winners and Contract Rules

Reality television rules are not set in stone. A contestant that is “out” can be brought back on and several winners or no winners can be declared. Tradesports has attempted to take that into account in their American Idol contracts.

The margin requirements and payouts make these tricky to trade profitably. All of the Outright Winner contracts remain open until the final winner has been announced to take into account that a contestant can be brought back. No matter how good you are at picking winners the margin will be tied up for a while. Fortunately there is a “Sent Home This Week” contract but it has much less volume than the Outright Winner ones.

The biggest gotcha would be if two winners or more winners were declared, according to the Contract Rules on Tradesports, “Should there be two official winners, both relevant contracts will expire at 50. Should there be three official winners the relevant contracts will expire at 33 etc.” How betting sites that give straight odds will handle the above scenarios is unclear.

Recent Articles and Resources

This New York Times article discussed some interesting handicapping techniques. The most accurate one seems to be DialIdol.com which counts the times a contestants line is busy. The harder is it to get through, the more votes the contestant is getting. This site is a must for Idol bettors.

Hitwise is also mentioned in the article and measures and contestants internet popularity. Although it predicted the bottom three last week, it is not a real time measure. The votes are directly related to that night’s performance, it would be hard to pick winners using this.

http://www.realitytvmagazine.com/blog/american_idol/index.html Follows the contest and even makes some bold gambling predictions. Worth a read.

http://www.gambling911.com/American-Idol-News.html Its exactly what the URL looks like, but doesn’t focus on prediction markets.

The Awards That Matter

Do not miss The Chris F. Masse 2005 Awards List:

http://www.chrisfmasse.com/2/2006/2006-03-06_prediction_markets_awards.html

Mandatory for even a casual observer.

Put Your Money Where Your Mind Is

A site that I've been reading more and more, TCS Daily had this article, Put Your Money Where Your Theory Is (borrowing Tradesports' tagline). The writers' idea is that academics that back up their predictions in cash will either be more accurate in their predictions or more moderate in predicting worst case scenarios to avoid the embarrassment of being so wrong. This one is worth a skim.

http://www.tcsdaily.com/article.aspx?id=030106E

"Moreover, prediction markets are non-ideological: the future happens the way it happens. Thus although Julian Simon beat Ehrlich, there are now scientists concerned about global warming who want global warming skeptics to put their money where their mouths are." - This would be entertaining.

"Will teen pregnancy be higher in 2010? Teens are apt to have better information about this than sociologists." - This example seems to be plain wrong. From a bettors perspective I'm not sure if I would be willing to trade based on the "inside tips" and four year predictive powers of my 15 year old cousin.

The market can restrain people since their predictions would be backed up with cash but the real incentive would be accuracy. For reasons of practicality (carry costs, liquidity) the bets will be made for prestige not profit.

Measuring What Matters

An instinct for the capillary

“But as the blogger Tim Cavanaugh notes, the smart money is taking his side: "After a weeklong bump into the double digits, the Dick Cheney June 30 retirement futures at intrade.com have plummeted; they are now below where they were before the shooting."”

While this politically focused article only mentions intrade in passing, it shows how prediction markets have come from being objects of curiosity to actual reference points in news stories. It also shows that despite the headlines people have not had a significant change in opinion because of the shooting incident. Cheney hasn’t felt any real pressure to resign and the hunting accident didn’t change that.

If you remember the 2004 debates, there was endless sniping about who “won” after each one. Polls weren’t that useful because they were so tainted with politics they didn’t track what really mattered: who would win the election. Fortunately the market did. And what it showed was a few percentage point move after the debates to none at all. In other words the debates didn’t change anyone’s mind or have any other effect on the odds. You wouldn’t know it from the hours of TV and gallons of ink wasted on the topic. As Cheney’s case shows, if you really want to know what is going on, follow the market not the headlines.

Prediction Markets vs Bird Flu

Academic approach with its expected excuses:

"The Iowa flu market cultivates contacts in emergency rooms and pharmacies within the state. But an avian flu market, Nelson said, would require participants in Asia and traders with specialized profiles, such as microbiologists who examine data worldwide.“We’ve not yet tapped into the right circles to get access to those traders,” he said. “That has kept us from opening an avian flu market.”"

Capitalism in action:

"Meanwhile, Trade Exchange Network recently closed one avian flu prediction market and is winding down another. In the first market, traders bought and sold futures contracts on whether avian flu would be confirmed in the United States by the end of 2005. The other market has traders testing hunches regarding a confirmed U.S. outbreak by March 31. The flu market operates on Trade Exchange Network’s Tradesports Web site."



Fighting the flu -
From game theory to flu chips, researchers experiment with new technologies to help thwart upcoming health catastrophes

End of the year trading strategy: Whack-a-Mole

This strategy is focused on small–cap stocks, not prediction markets, and is similar to the whack-a-mole carnival game. In the entertaining boardwalk staple players use a mallet to smash the heads of any mechanical moles foolish to stick them out, the more you smashed the better you did. The idea here is to short as many small-caps as we can that have an end of the year bump during the last days of trading.

Although we haven’t seen it in the last week, financial publications at this time of year talk frequently about an, “end of the year rally.” Rather than traders squaring away positions before the New Year, hedge funds and money managers participate in a year-end scramble to “paint the tape” or run up their portfolio solely for valuation purposes. The reason this occurs is because absolute returns for money managers DO NOT MATTER. What matters is beating the benchmark.

How managers get paid is by the % that they exceed the benchmark for a period. Since valuations are normally done at the end of the quarter many Wall St. participants have incentive to run up their equities on the valuation date to get the maximum bonus possible. Of course since there is no fundamental change in valuation, stocks fall back down after the date passes. The reason it is so pronounced at the end of the year (in theory) is that there is a big decrease in volume so it’s easier for the pros to push the market around.

Since we don’t have to meet benchmarks, we can trade with a focus on returns not short term chicanery. Rather than guess who owns what and who has incentive to paint the tape we can screen for small caps that have gone up 5% or more this past week with no change in fundamental and short as many of them as we can. Short term and simple, everyone that sticks out we hit back down.

Unfortunately, with the Dow flat we may see fewer opportunities than last year so focus on sector bets that have had a gain to beat.

High Prices and Large Spreads: The Effect of Transaction Costs and Excess Choices in Prediction Markets

Looking at the Academy Award for Best Actor we can see that the current offers add up to 218.2, very overpriced. Since the prices of the contracts are approximately the percent chance of the contract paying off we can tell the market is overvalued. If everything was priced accurately the percentages should add up to around 100 (it will always be a little more due to the spread). Think of an election with two candidates; there will only be one winner. The chances of success for both candidates should add up to 100%, e.g. Candidate A has a 30% chance of winning so Candidate B should be at 70%. The highest chance of someone winning is 100%, so if the market is factoring in more than that it is over exuberant.

Since the market is factoring in over 200% chances of winning the Best Actor Academy Award there should be several opportunities to short the market. Unfortunately when we look at the sell side, the spread is so wide that the opportunities disappear. The Bids total up to only 92%. Not only are the spreads wide but in some cases the other side of the trade doesn’t exist. For instance on Crowe as Best Actor the Offer is 4.9 with 0 on the bid. What is happening here is that the chance of Crowe winning is so small that there is no incentive to take the other side of a guaranteed losing trade. In theory the contract can trade low enough to generate interest, but because of transactions costs it isn’t going to happen. No one can make money selling at the real odds so the market ceases to exist.

That leads to the next reason why the huge disparity between bids and offers exists; too many betting choices. With so many options, each with their own bids and offers, the market has trouble closing the gap. For instance, the GOP Nomination has 26 different candidates that you can take a position on. With volume of over 80,000 contracts the market is fairly deep but the spread between the bid and offer has stubbornly refused to close and remains at 21.3 (Bid 96.6 – Offer 117.9). Similar to our trader who will sell Crowe at 4.9 but wouldn’t buy at any price, the long shots skew the market. The more choices, the wider the gap between the bids and offers, even when sufficient liquidity exists. Looking at the Canadian Elections, a trade with only three choices, we can see more rational pricing. The spread is only 7.25 (Bid 98.2 – Offer 105.5) even though liquidity per contract is substantially similar to the GOP Nomination (3,076 GOP vs. 3,259 CAD contracts traded).

Not only is contract volume a factor in closing the spread between bid and offers, the number of choices are as well. However we expect the market to rationalize as the expiration approaches and the smart money begins to pay more attention.