Is Manipulation Good for a Prediction Market? Accuracy Isn’t Everything.
Eric Zitzewitz July 9th, 2007
Michael Giberson made a point in a recent post that is worth repeating:
“I think the potential for manipulation troubles some prediction market folks because it puts an implied asterisk next to any prediction market price that says “caution: the price you currently observe in this market may not truly represent the collective opinion of the population of traders, but instead may reflect an attempt to manipulate the market outcome.” The possibility of manipulation taints the purity of the price as a predictor.”
In other words, even if in a rational expectations equlibrium the anticipated presence of manipulators increases prediction market accuracy, that may not be the same thing as it being good for a prediction market.
As sources of inaccuracy go, people dislike manipulation a whole lot more than (honest) noise. For three (non-behavioral) reasons:
1. People have a taste for institutional integrity itself.
2. The possibility for manipulation creates bad incentive effects. Think of a social planner who has to chose whether to base a policy on a noisy, but manipulation-free, signal or a less noisy but manipulable signal. Putting weight on the latter has incentive effects that can produce behavior that offsets the benefit of a more accurate signal for policy choice.
3. Noise is easier to mentally model. Manipulation, to be successful, relies on surprise. Thus, by definition, if its successful, it’s going to be harder for users of prediction markets to understand. And a hard to understand source of uncertainty is more vexing to users of a prediction market price than just simple noise.
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I like your counter reasons, but tend toward the view that rather than disdain manipulation, prediction markets should adapt to the inherent possibility of manipulation.
There is a certain amount of irony present in the ‘manipulators subsidize informed traders’ idea, which may be why I focused on the ‘good news’ about manipulation. You present some useful balance to my one sided presentation. The next interesting issue is, given the pluses and minuses surroundings manipulation, what to do about it. I’ll post my thoughts on this topic in a day or so.
Response is up: What should be Done about Manipulation of Prediction Markets?
It would be nice to see a more concrete model of your #2 concern, to see if a coherent story can be constructed to reify it. Your #3 concern is really the same one; people could just model manipulation as simple noise, but they might feel they need a more elaborate model if in fact something like #2 might be going on.
Michael,
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I don’t think you fully understand the risks associated with market manipulation.
The entire financial system could have collapsed not so long ago.
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Sally Dewar, managing director, wholesale and institutional markets at the FSA, said: “There has been a series of completely unfounded rumours about UK financial institutions in the London market over the last few days, sometimes accompanied by short-selling. We will not tolerate market participants taking advantage of the current market conditions to commit abuse by spreading false rumours and dealing on the back of them”.
“We remind market participants of the need to take extra care, in this market climate, to adhere to the market code of conduct,” she said.
http://www.guardian.co.uk/busi.....editcrunch
There is market manipulation through weight of money, trying to squeeze a market if you are a relatively big trader (this works well in markets where real information is scarce, but there is a high level of fear that someone knows something).
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However, market manipulation also incentivizes corruption of information given to market participants, e.g. deliberate scare stories at a time when the market is already jittery, can have a powerful effect, as was seen very recently in the UK by the example medemi gave.
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Overall, I’m disinclined towards the view that profits should accrue in any market to people who deliberately try to deceive other market participants, in an attempt to profit from scaring others. It results in a non Pareto-optimal allocation of resources in the economy.
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One (of many) examples from the sports markets happened when someone writing the weather reports for the BBC website two years ago mysteriously predicted heavy rain whenever there was a cricket test match coming up. (Rain sends the draw price crashing from normally about a 1 in 3 chance to an odds on favourite). This crashed the BF price on the draw in cricket test matches, until people stopped believing the BBC website weather reports. Imo, you have a responsibility to be honest as a journalist, and do the job you are paid for.
My God, Ed… What a country you live in, if you can’t even trust the weather report anymore.
I knew it was fucked up, but it never seizes to amaze me.