The UK political prediction markets are starting to get fun.

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The British Republicans (&#8220-the Tories&#8221-) have dipped a bit more at BetFair, yesterday, and everybody is wondering why. (See the first comment in the second link.) Expect Max Keiser to weight in. We are going to have fun this spring, I kind of feel that in the air. :-D

UPDATE: Bad poll for the Tories.

The New York Times on InTrades US political election prediction markets

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The NYT writers discusses 2 (different?) issues.

#1. There was market arbitrage opportunies in the recent past between InTrade and BetFair &#8212-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.

#2. The NYT writer reports (without linking to it) the findings of the InTrade investigation about the behavior of their unnamed &#8220-institutional investor&#8221-.

– 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&#8217- 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.

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

Political prediction markets should move beyond mere horse-race forecasts to demonstrate larger social value.

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I agree with that.

The key, now, is to go beyond the accuracy issue and to move on to the utility issue.

It&#8217-s a much complex problematic, which those who have been over-selling the prediction markets are unwilling to undertake. [*]

Maybe a small bunch of prediction market people, maybe assembled in a new prediction market structure, might go for that lofty goal of fingering the specific instances where prediction markets create real social utility.

[*] Yelling across the harbor, like an illuminated Jesus Christ, that prediction markets can help &#8220-avoiding future [financial] crisis&#8221- is a sign that some prediction market practitioners have lost their intellectual compass. To my knowledge, InTrade hadn&#8217-t had any prediction market focused on the &#8220-looming credit crunch crisis&#8221-, last summer. Its CEO should be careful about making any grand statement. As I wrote many times, at best, the prediction markets are the best umpire you can have between either the mass media and the politicians, on one hand, and a group consisting of the best experts, on the other hand. An umpire is only useful during critical times, in a game. But, other than that, most of the times, the umpire is not the determinant of the game &#8212-the players are.

The researchers and practitioners should make a solid case for each of these critical instances where the prediction markets have a real social utility.

Stop the over-selling. Let&#8217-s start the real work.

InTrade offers an explanation of strange trading.

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Intrade has made a statement on the unusual trading that many have noted and alleged to be manipulative. The statement suggests that the price action is mostly attributable to a single firm, a hedger &#8220-using our markets in good faith and in the ordinary course of their business.&#8221-

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&#8217-t fully explained.

Whether or not it was Centrist isn&#8217-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&#8217-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&#8217-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 ]

The blogger at Marginal Revolution misinforms the public by repeating the misinterpretation thrown around by liberal hack Paul Krugman about the alleged manipulation on the InTrade prediction markets.

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Alex Tabarrok writes that &#8220-someone was manipulating Intrade to boost John McCain&#8217-s stock price&#8221-.

No&#8230-!!!&#8230-

John Delaney said that that firm has been hedging on InTrade &#8212-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.

There is no manipulation going on in the InTrade political prediction markets.

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– InTrade CEO John Delaney has conducted an investigation on the alleged manipulation. The suspicious moves in prices were in fact caused by the buying and selling made by an &#8220-institutional&#8221- trader (a hedge fund, I presume) who has been managing &#8220-certain risks&#8221- (hedging).

– Jason Ruspini, who wrote before this report came out, does believe that manipulations &#8220-non-informational&#8221- trades have been prevalent on InTrade. (We will see whether Jason changes his mind in light of InTrade&#8217-s debunking report.)

2008 US Presidential and Congressional Elections Prediction: The Sarah Palin effect has partially evaporated, but its remains point to a close race, come Tuesday, November 4, 2008.

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#1. Explainer On Prediction Markets

Prediction markets produce dynamic, objective probabilistic predictions on the outcomes of future events by aggregating disparate pieces of information that traders bring when they agree on prices. Prediction markets are meta forecasting tools that feed on the advanced indicators (i.e., the primary sources of information). Garbage in, garbage out&#8230- Intelligence in, intelligence out&#8230-

A prediction market is a market for a contract that yields payments based on the outcome of a partially uncertain future event, such as an election. A contract pays $100 only if candidate X wins the election, and $0 otherwise. When the market price of an X contract is $60, the prediction market believes that candidate X has a 60% chance of winning the election. The price of this event derivative can be interpreted as the objective probability of the future outcome (i.e., its most statistically accurate forecast). A 60% probability means that, in a series of events each with a 60% probability, then 6 times out of 10, the favored outcome will occur- and 4 times out of 10, the unfavored outcome will occur.

Each prediction exchange organizes its own set of real-money and/or play-money markets, using either a CDA or a MSR mechanism.

More Info:

– The Best Resources On Prediction Markets = The Best External Web Links + The Best Midas Oracle Posts

– Prediction Market Science

– The Midas Oracle Explainers On Prediction Markets

– All The Midas Oracle Explainers On Prediction Markets

#2. Objective Probabilistic Predictions = Charts Of Prediction Markets

Put your mouse on your selected chart, right-click, and open the link in another browser tab to get directed to the prediction market page of your favorite exchange.

2008 US Elections

InTrade

2008 US Electoral College

2008 Electoral Map Prediction = InTrade – Electoral College Prediction Markets = Probabilistic predictions for the 2008 US presidential elections based on market data from InTrade = electoralmarkets.com

– This is a dynamic chart, which is up to date. Click on the image, and open the website in another browser tab to get the bigger version.

Mitt Romney [or Sarah Palin] will be the Republican vice presidential nominee.

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Tim Pawlenty won&#8217-t go in Dayton, Ohio. So, it&#8217-s Mitt Romney.

The play-money and real-money prediction markets were easily fooled with the Pawlenty rumors, yesterday.

That vindicates my message that the VP prediction markets feed on unreliable primary indicators.

I said from day one to be careful with the VP prediction markets.

I told you so.

UPDATE: It&#8217-s probably Sarah Palin.