Despite some limited evidence, the insistence on traders needing to know the direction of manipulation isn’t too compelling since the direction will be manifest insofar as the price is “wrong.” “Noise trader” is a politically loaded and misleading term. Misleading because it suggests that the mean effect will be zero, when in reality “noise trading” usually takes the form of feedback trading. Lack of feedback trading is a significant assumption in the Hanson manipulation papers. Fortunately, prediction markets have objective settlements at specified times, unlike traditional assets where the meaning of prices is open to interpretation, making them more prone to feedback trading and irrational booms and busts.

With prediction markets, conditions for manipulation are more favorable when the settlement is far off in time, and when there are subjective inputs to the settlement, e.g. in politics. A distant settlement simultaneously makes it less clear what the real price should be, and delays manipulator losses because there is less incentive to correct price. At the limit, a manipulator could introduce a price distortion when a contract is launched, only to reverse position for small liquidity-related loss immediately before settlement, thereby destroying the markets “integral” of error over time.

Another big assumption, also identified by Paul Hewitt, is that traders have equal account sizes. But maybe this isn’t a huge problem if settlement is forthcoming, and maybe the issue could be mitigated with additional exchange disclosures, such as the standard deviation of position sizes in a given market. While this could discourage liquidity as large traders would become paranoid about their positions, it is essentially a “soft” position limit, and traders would be forewarned of one-sided markets (which could of course be the result of someone well-informed, but I – the google-anonymous* writer – would bet that more concentration comes with more error on average… this can be tested by someone with the data, of course maintaining trader anonymity)

Even accounting for long-term settlement, feedback trading, semi-subjective settlements, and account size imbalances, it seems one would have to abide to an overly rigid tenet of “do no harm” to hold that prediction markets are, on net, a bad idea. (Do no harm is of course abhorrent to libertarians, and even doctors don’t actually follow such a rule.) Moreover, some pathologies like political self-fulfilling prophecy will only happen if prediction markets have already demonstrated their value and have become more popular. But even if one believes in their long term success, single pathologies can damage one’s reputation permanently… if one plans to die at a reasonable age.

[*Given the political climate, many firms have issued directives to employees to not engage in even the slightest appearance of impropriety, which might include blogging on manipulation.]

Will market manipulation for political candidates become the norm as ever-wealthier campaigns try to control the news cycle?

No…!!!…

John Delaney said that that firm has been hedging on InTrade —a normal and beneficial activity on the other (larger and more liquid) financial markets.

InTrade is not liquid enough to weather (quickly enough) the impact made by the hedging activities, at this time, but will in the future, if growth continues.

Manipulation is bad.

Hedging is good.

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#1. There was market arbitrage opportunies in the recent past between InTrade and BetFair —unlike 4 years ago, and contrary to the laws of economics.

- The price of the Barack Obama event derivative was cheaper on InTrade than on BetFair and the Iowa Electronic Markets. Conversely, the price of the John McCain event derivative was more expensive on InTrade than on BetFair and the Iowa Electronic Markets.

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#2. The NYT writer reports (without linking to it) the findings of the InTrade investigation about the behavior of their unnamed “institutional investor”.

- InTrade CEO John Delaney suggests that that institutional investor:

1. might operate on InTrade at specific times where it might not be able to find liquidity on BetFair and/or IEM;
2. might be a bookmaker willing to hedge its risks on a prediction exchange (a.k.a. betting exchange).

- Justin Wolfers’ PHD student remarks that that institutional investor is not making an effort to shop around for the best prices, within each InTrade political prediction market.

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RELATED: See the comments on Midas Oracle here, here, here, and here.

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Exactly.

John Delaney said that that firm has been hedging on InTrade —a normal and beneficial activity on the other (larger and more liquid) financial markets.

InTrade is not liquid enough to weather (quickly enough) the impact made by the hedging activities, at this time, but will in the future, if growth continues.

Manipulation is bad.

Hedging is good.

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As a way to thank Zubin Jelveh for his admirable coverage of the prediction markets, please do subscribe to his economics blog, Odd Numbers.

• Odd Numbers @ Portfolio — category: “prediction markets“
• Put that URL in your feed reader:
• http://feeds.portfolio.com/portfolio/oddnumbers
• Mister Zubin Jelveh, thank you.
  

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No…!!!…

John Delaney said that that firm has been hedging on InTrade —a normal and beneficial activity on the other (larger and more liquid) financial markets.

InTrade is not liquid enough to weather (quickly enough) the impact made by the hedging activities, at this time, but will in the future, if growth continues.

Manipulation is bad.

Hedging is good.

The first company that comes to mind is Centrist Messenger. Centrist is an interesting firm that re-sells political ad time and refunds sales to customers whose candidate loses. Centrist has stated publicly that it uses Intrade to hedge this exposure.* If Centrist had something to do with the unusual trading, it suggests that they sold more Obama than McCain ads, creating exposure to a GOP victory, resulting in McCain buys and Obama sales on Intrade. Why such a firm would be such urgent price-takers isn’t fully explained.

Whether or not it was Centrist isn’t important, but as these markets mature we should expect them to attract more hedging activity, and this might introduce persistent price distortions. Indeed it makes sense for people in the top tax bracket to be long Obama apart from considerations of his chances of victory. This is another uncomfortable subject that I’ve warned about in the past. When these markets become deeper and more widely available, the odds of the high-tax candidates might begin to show an upwards bias, a risk premium. Interestingly, Musto and Yilmaz predict that such markets will eventually lead to increased promises of redistribution by candidates. Talk about unintended consequences.

Intrade is doing the right thing here though, dealing with tough issues realistically and with as much transparency as possible. They provide valuable information, for free, even in places where they are not necessarily welcome. The depth of this information helps us to evaluate Intrade prices and have more confidence in them. Here is an example below, based on Obama’s market over the past two weeks. Some have noted that the purported attacks occurred in hours where the market was unusually thin. This chart measures such price manipulability. The red line represents the ease of a downwards attack. It is the 100 x the amount of margin required to sweep the top fifteen bids divided by the difference between the highest bid and the fifteenth highest bid. (That is, how much the probability of an Obama victory can be moved by risking $100. Commissions are not taken into account but would of course would be vital.) The green line is the ease of an upwards attack. This is a very preliminary study and I will leave it to others to voice initial impressions. The fact that we can gauge to what extent traders are exercising market power is in itself important and encouraging however.

* Technically another firm does the trading. Centrist is incorporated in the US, and the trading firm is incorporated in St. Kitts. Through this arrangement, Centrist cleverly avoids violating UIGEA.

[Cross-posted from Risk Markets and Politics ]

No…!!!…

John Delaney said that that firm has been hedging on InTrade —a normal and beneficial activity on the other (larger and more liquid) financial markets.

InTrade is not liquid enough to weather (quickly enough) the impact made by the hedging activities, at this time, but will in the future, if growth continues.

Manipulation is bad.

Hedging is good.

No…!!!…

John Delaney said that that firm has been hedging on InTrade —a normal and beneficial activity on the other (larger and more liquid) financial markets.

InTrade is not liquid enough to weather (quickly enough) the impact made by the hedging activities, at this time, but will in the future, if growth continues.

Manipulation is bad.

Hedging is good.

- Logical flaw?

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ADDED BONUS: Additional thought on arbitrage.

UPDATE: The HubDub PM on who will win the 2nd debate.