Beware before citing the probabilistic predictions given by the prediction markets

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Steve Roman:

It’s good to see Intrade cited as authoritative but I don’t think the recession contracts have enough liquidity to accurately reflect the odds. Citing a contract price when there is only a small amount of liquidity is one issue the MSM does when the number may not be credible. Some others that come to mind:

1. Thinly traded contracts may not reflect true odds – For instance, the contract for the US entering a recession in 2008 is now trading at 31. A pundit may cite this as a 31% chance of the US entering a recession in 2008, but he would not note that there is a 10-point spread around that price, so that by trading one lot, the odds will change by 5 points up or down. It would be a meaningless move – or would it? In such a thin market it impossible to tell.

2. Contract rules are importantWill Larry Craig resign? Did a missile leave NK airspace? The contracts for these events were based on rules that could be interpreted to have the opposite meaning of what most people would assume they do.

Even with Intrade’s recession contracts the details are important. The contracts will pay off when there are two consecutive quarters of negative GDP growth. That’s easy to understand, but is only one definition of recession. In the US a recession starts when the NBER says it does, making it possible for the GDP definition and contract odds to show we are not in a recession as the NBER declares we are. Not a major issue, but one that should be disclosed.

3. Timeframe should be noted – US News is the latest violator of ignoring time frames when discussing price changes, http://www.usnews.com/blogs/capital-commerce/2007/10/16/recession-odds-continue-to-fall.html . When talking about price changes it is necessary to talk about the time period over which the changes occurred. Did the odds of a recession decline from 60% to 30% within the past week? The past month? Not citing a timeframe or including a chart means I have to go back to Intrade to check on my own.

Steve Roman’-s blog: Nasty Brutish And Tall

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3 thoughts on “Beware before citing the probabilistic predictions given by the prediction markets

  1. Jason Ruspini said:

    Intrade also had Al Gore trading above Obama for the nomination days ago in a thicker market.. and still has Gore bid in the 4s.

    What the CFTC is doing is sad. I heard something encouraging about them recently, but given the state of Hedgestreet, I’ll believe it when I see it.

  2. Michael Giberson said:

    This post should be labeled a “must read” for journalists citing prediction market numbers.

  3. Chris. F. Masse said:

    … a “must read” for prediction market bloggers like Chris Masse, too. :-D

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