
Prediction Markets - gwern
http://www.gwern.net/Prediction%20markets
======
hooande
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] [http://go.bloomberg.com/political-
capital/2012-06-29/intrade...](http://go.bloomberg.com/political-
capital/2012-06-29/intrade-bettors-lost-on-health-care/)

~~~
jonnathanson
Exactly right.

 _" 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.

~~~
aamar
_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._

And one extreme version of this is mounting a credible campaign then
"throwing" the race or withdrawing abruptly. This is attractive whenever the
possible winnings in the prediction market are large and the market is
insufficiently regulated. In ordinary financial markets, there can be special
scrutiny paid to shorts, but the zero-sum game structure of a prediction
market loses the distinction.

~~~
jonnathanson
True, although not every trade is zero-sum _per se_ , depending upon the
prediction market. More sophisticated trading strategies involve profiting off
of the changes in probability of a given outcome over time (or at least the
changes in _perception_ of that probability), rather than simply buying and
holding a one-sided bet on fixed odds. They amount to psychological
manipulation of the market, buying and selling the same positions over time at
local minima and maxima.

You're absolutely right about the power to "throw" a prediction market,
however, provided the right parties can conspire to do so. This is essentially
what Arnold Rothstein and associates did in fixing the 1919 World Series. Most
people casually assume the fixers bribed the players to throw the game, then
profited off the results. In actuality, their strategy was slightly more
nuanced. They spread the _rumor_ that the game had been fixed long before they
actually fixed the game, thereby forcing an adjustment of odds on (illegal,
unregulated) gambling books. This allowed them to hedge long against their
predominantly short bet, covering them adequately in the event that the fix
was insufficient to adjust the game's most likely outcome.

------
spindritf
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?

(Anyone selling futures for that?)

~~~
presidentender
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.

------
jedc
There was a prediction markets company that YC funded in its second-ever
batch: Inkling Markets.
([http://inklingmarkets.com](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.)

~~~
joosters
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.

~~~
gwern
They don't, but judging from their messages on their homepage, they've gotten
forbearance from their biggest creditors.

------
Permit
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?

Edit: Apparently they've just recently started using real money at some
prediction markets:
[http://en.wikipedia.org/wiki/Prediction_market#Legality](http://en.wikipedia.org/wiki/Prediction_market#Legality)

~~~
lifeformed
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?

~~~
WarDekar
You're thinking of Assassination markets [0]

[0]
[http://en.wikipedia.org/wiki/Assassination_market](http://en.wikipedia.org/wiki/Assassination_market)

~~~
gwern
I find assassination markets a fascinating concept: I wrote a short story
about them (
[http://www.gwern.net/fiction/The%20Ones%20Who%20Walk%20Towar...](http://www.gwern.net/fiction/The%20Ones%20Who%20Walk%20Towards%20Acre)
) and pondered whether they might be a successor to Silk Road
([http://www.gwern.net/Silk%20Road#future-
developments](http://www.gwern.net/Silk%20Road#future-developments) probably
not).

------
btilly
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/](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
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!

~~~
btilly
That is why the JavaScript tools I wrote to go with the article can give you
percentiles on where you would be after different numbers of trials. That's
explicitly so that people can develop intuition about how much they need to
underbet to stay within their comfort levels.

------
peterjancelis
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.

[1]
[http://en.wikipedia.org/wiki/Assassination_market](http://en.wikipedia.org/wiki/Assassination_market)
[2]
[http://en.wikipedia.org/wiki/Jim_Bell](http://en.wikipedia.org/wiki/Jim_Bell)

------
woodchuck64
What's the status of Intrade? Will it be back?
([http://www.intrade.com/v4/home/latest-
news/](http://www.intrade.com/v4/home/latest-news/))

~~~
chimeracoder
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).

------
jasich
Hey, I've created a site for making/tracking predictions called The Red Book
([http://rdbk.net/](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.

------
joelthelion
I'm still waiting for a good Bitcoin-based prediction market. I think that
would be a nice application for the cryptocurrency.

~~~
gigq
Isn't this what [http://betsofbitco.in](http://betsofbitco.in) does?

~~~
gwern
They do, but extremely poorly. I criticize them in the OP:

> One might wonder why I don't use the fairly active [Bets of
> Bitcoin]([https://en.bitcoin.it/wiki/Bets_of_Bitcoin](https://en.bitcoin.it/wiki/Bets_of_Bitcoin))
> prediction market; that is because the payout rules are
> [insane]([http://betsofbitco.in/help](http://betsofbitco.in/help)) and I
> have no idea how to translate the "total weighted bets" into actual
> probabilities. Betting blind is never a good idea.

------
ptype
If you are interested in prediction market type betting and got friends who
like the same, you might like
[http://www.bespokebets.com](http://www.bespokebets.com) which lets you setup
your own market easily and for free (play-money - and yes talking my book)

------
laoheike
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](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
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.

~~~
joosters
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."

~~~
pdonis
_the predictions tend to get better_

Only if there is some actual predictive skill out there to begin with. For
example, the article gives the example of a prediction market on coin flips:
the winning strategy is to take any bet for less than $1 (assuming that the
payoff on a successful prediction is $2). But in short order, everyone who
does not play that strategy will go bankrupt, and then there will be no more
betting, because everyone remaining in the market will only take a bet at less
than $1, but nobody will be willing to offer one. In other words, if there is
an obvious limit to how well something can be predicted, the market will reach
that point and then _stop_ \--no further betting will happen.

~~~
joosters
Not true at all! A golden example is Betfair's 'exchange games' markets, where
they let players bet on fair, computer-managed card games. The markets are
always exactly prcied-up. Some punters are playing, but even without the
'mugs' you can just look at the order book to see the predictions.

For the coin flip, you'd still have people asking for odds of 50.1% and others
offering odds of 49.9% - you then can just look at the spread to discover the
market prediction.

~~~
pdonis
_The markets are always exactly prcied-up._

Isn't this in agreement with what I said? I didn't say that the market prices
would not reflect the expected predictions. I said that once that happens the
market will stop moving, which appears to be exactly what you're saying:

 _you can just look at the order book to see the predictions._

In other words, there is a limit to how accurately people can predict the
outcomes of these card games, and that limited predictive accuracy is what the
market reflects. The real question is, how much betting _volume_ is there for
a given, fixed card game, once all the players in the market learn the odds?
My expectation is that volume will decrease over time for a given, fixed card
game, because if the game is fair, the betting is zero-sum, so players who
know the optimal strategy will never bet among themselves (since you can't
make money on average at zero-sum bets), and players who don't know the
optimal strategy will go bankrupt.

Obviously if you introduce a new card game, the above doesn't apply; that
would be the equivalent of adding, say, six-sided dice to the coin flip
betting site: now there's a new set of odds to be learned, so there will be a
new period of trading as market players learn the optimal strategy for this
new game.

 _For the coin flip, you 'd still have people asking for odds of 50.1% and
others offering odds of 49.9%_

Would any actual bets happen at these odds? What makes you think so? An
occasional new player might try this, but he would end up losing money, and
all the long-term players know that would happen, so they won't try it. Why
would they?

Or do you just mean that people would be posting these asks/offers, but nobody
would be accepting them? If so, then, once again, this is in _agreement_ with
what I was saying; no actual activity would be taking place in the market, but
the asks/offers would accurately reflect the market's best available
prediction--which is the best _possible_ prediction, hence no money can be
made in the market because trades are zero-sum.

~~~
joosters
I was writing to highlight your seeming disagreement with the text you quoted:

 _the predictions tend to get better_

You seemed to be saying that this was not the case, citing a coin flip. My
counter argument is that a real-world prediction market for (effectively) a
coin flip tends towards a 'perfect' prediction. It can then stay in this
steady-state regardless of whether or not any fool continues to bet; you just
have to glance at the order book of unmatched bets to discern the prediction.

So, the predictions do tend to get better, even if you have unskilled
participants. Or are you saying "predictions only get better if people are
good at predicting", which would be stating the bleeding obvious, right?

(Disappointingly, Betfair's exchange games still seem to have money traded on
them, and they run these games every minute of the day.)

~~~
pdonis
I wasn't saying the predictions never change; I was saying that they will only
change as long as there is knowledge about the outcome that has not yet been
priced into the market. The market "not changing" does not mean it does not
have a market price: it just means that the market price is constant (and that
therefore there is no trading happening, except for the occasional new player
entering and quickly losing money by playing a non-optimal strategy). You are
saying the same thing, just in different words.

 _the predictions do tend to get better, even if you have unskilled
participants_

This statement as it stands is way too strong, which is why I originally
objected. The correct statement is: "predictions will tend to get better as
long as it is possible for the average skill level of the market participants
to increase". You're right that participants don't have to start out being
skilled; but the average skill level of the participants does have to be able
to change for the market's predictions to change.

In the coin flip prediction market, that can't happen (or at least it can't
happen for very long), because the optimal strategy for betting on coin flips
is so obvious. In the Betfair card games, there is some scope for increasing
participant skill, but there can't be very much if the games are fair; people
will fairly quickly figure out the optimal strategy for any given game, and
soon after that the market will stop trading if the players are rational. (You
appear to agree with this, since you say it's "disappointing" that Betfair's
games continue to have money traded on them.)

Of course these are simple examples; what about real-world prediction markets?
What about, for example, betting on sports games? My sense is that a similar
effect occurs there: the average skill level of the long-term market
participants is relatively unchanged over time, and therefore the accuracy of
the predictions that can be extracted from the order book is relatively
constant over time. The reason money is still made in these markets is that
there is a basically inexhaustible supply of new players who think they know
more than they actually do, and who therefore quickly end up losing their
money to the long-term players--much the same thing that happens in casinos.

------
JackFr
I predict that the sum of my cards will be closer to 21 without going over
than the dealer's will.

------
ffrryuu
Gambling.

