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The gamble of downplaying manipulation

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Whether it is GOP bias, manipulation, or simply confident well-funded traders, there is some agreement that the Intrade presidential markets have been affected by &#8220-non-informational&#8221- trading. To be clear, this is not a condemnation of Intrade. The exchange&#8217-s liquidity and trader diversity are hamstrung by archaic laws in the U.S., the continuation of which will frustrate a fair assessment of market accuracy. The point is that arguing for legal and regulatory change while downplaying the viability of manipulation and other market pathologies is counterproductive.

That prediction markets may be manipulated with some persistence should be no surprise to anyone who has followed the subject in the past couple of years. Here is a sampling of some of the warnings:

The HRC attack, part 2
The Giuliani manipulator buyer is back.
Manipulation can affect prices.
Is there manipulation in the Hillary Clinton Intrade market?
Is there manipulation in the Hillary Clinton Intrade market? Redux
Measured Enthusiasm For Prediction Markets

We now even find some academic papers that admit that manipulative trading may be profitable given certain assumptions. It is up to readers to decide which papers contain the most &#8220-stylized&#8221- assumptions.

No-one argues whether, in the long run, in general, manipulation is a losing proposition that subsidizes other traders — but is it really prudent to deploy that message, in comments to CFTC for example?

First, if Obama wins the election, based on the other available markets and poll projections, it would seem that an error had been introduced into the largest and most widely-cited of prediction markets. When comparing market and poll accuracy over time we are usually talking about only a few percentage points difference, so this error isn&#8217-t trivial. Furthermore this is a market that takes place only once every four years, so long-run arguments ring a little false. There&#8217-s no reason why something similar couldn&#8217-t happen in 2012. At least, one is optimistic that the regulatory situation will improve and Intrade&#8217-s traders will be more numerous and less capital-constrained at that time, which should make manipulation more difficult on average. Those who downplay the dangers of manipulation risk such goals by sacrificing their general credibility. It&#8217-s a negative skew proposition.

Second, some markets can irreversibly affect the outcome they predict. This happens infrequently and requires some fundamental basis, but specific cases can spectacularly undermine a general argument. This is the old bit about trying to cross a river that&#8217-s three feet deep on average. An example we&#8217-ve seen recently: when a business is predicated on maintaining a deposit base or borrowing short-term at certain rates, manipulation might be irreversible if it targets confidence or attacks the business&#8217-s funding costs. In essence, the manipulator forces the (possibly quite liquid) market to &#8220-settle&#8221- as the firm approaches insolvency, and prices do not snap back. Breaking a currency peg has a similar dynamic. Now, there is currently no real analog to these situations in prediction markets as such, but either these markets will continue to be relatively small and not widely-followed, or &#8230-.

Kenneth Arrow and Intrade CEO John Delaney are making the right arguments here: transparency in the form of more public markets, along with less concentrated risk, would have helped avoid this crisis. But don&#8217-t try to sweep uncomfortable subjects under the rug. That won&#8217-t end well.

[ Orginally posted to Risk Markets and Politics on Wednesday, 10/15 ]

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.

Our prediction market network at LinkedIn

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1. How To Join Us

  • From within LinkedIn, FaceBook, or Google Reader / Google Mail, send me an invite and I&#8217-ll accept it.
  • I can introduce you to another member of our business network. Just ask me (Chris Masse), and I&#8217-ll do.
  • You are also invited to join the Prediction Markets group at LinkedIn.
  • [As for joining Midas Oracle as a commenter or poster, see this other webpage.]

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2. LinkedIn Network

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The Prediction Markets group at LinkedIn.

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Chris Masse&#8217-s network at LinkedIn.

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Our Prediction Market People – (from the two networks listed just above)

– Bernd Ankenbrand (Gexid Manager)

– Maurice Balick (NewsFutures CTO)

– Pierluigi Buccioli (Entrepreneur and Betting Exchange Trader- Owner of Bookmakers Review)

– Jason Carver (Entrepreneur and Engineer)

– Yiling Chen (Professor at Harvard University)

– Norris Clark (Vice-President of Sales at NewsFutures)

– Tyler Cowen (Economics Professor at George Mason University)

– Bo Cowgill (Quantitative Marketing Manager at Google)

– Eric Crampton (Senior Lecturer at University of Canterbury)

– Noam Danon (Qmarkets CEO and Founder)

– Pedro Da Cunha (Exago Markets CEO)

– John Delaney (InTrade CEO)

– Juan Manuel Ducler (Founder, BestChartsOnline.com / Trader &amp- Financial Consultant)

– Nigel Eccles (HudDub CEO)

– Leslie Fine (VP of Market Design at Xpree)

– Matthew Fogarty (Prediction Market Consultant – Xpree CEO and Founder)

– Lance Fortnow (Professor of Computer Science at Northwestern University)

– Nick Garner (SEO / PPC / Search Manager at BetFair)

– Cedric Gaspoz (Research and Teaching Assistant at University of Lausanne)

– Michael Giberson (Energy Economist at Texas Tech University)

– Sean Glass (Founder, Chairman, Chief Strategy Officer at Pikum Holdings)

– Andrew Goldberg (Intern at Media Law Resource Center)

– Robin Hanson (Professor of Economics at George Mason University)

– Tim Harford (Journalist at The Financial Times)

– Chris Hibbert (Software Architect, Project Lead at Zocalo)

– Donna Hoffman (Professor and Co-Director, Sloan Center for Internet Retailing)

– Panagiotis Ipeirotis (Assistant Professor at New York University)

– Max Keiser (Entrepreneur, Journalist, Co-Founder of the Hollywood Stock Exchange)

– Alex Kirtland (User Experience Consultant)

– Ken Kittlitz (Software Architect, Foresight Exchange, Consensus Point)

– Greg Knaddison (Developer and Sys Admin for PingVision)

– Nathan Kontny (Inkling Markets CTO)

– Kriss Monaco (Director of New Product Development at International Securities Exchange)

– Dean LeBaron (Independent Investment Management Professional)

– Heidi Levin (Director of Business Development at Inkling Markets)

– Mike Linksvayer (Vice-President of Creative Commons)

– Rory Mackay (PredictionsMarkets.com Co-Founder and Owner)

– Chris. F. Masse (Founder and President of Midas Oracle)

– Tracy Mullen (Penn State Professor of Information Technology)

– Jesper Muller-Krogstrup (Managing Director of Nosco)

– David Pennock (Principal Research Scientist at Yahoo!)

– David Perry (Consensus Point President and Co-Founder)

– Daniel Reeves (Yahoo! Research Scientist)

– Steve Roman (Financial Analyst at FXCM)

– Jason Ruspini (Financial Research Analyst, Vice President at Conquest Capital Group)

– Mike Sankowski (Product Development and Market Operations Manager at US Futures Exchange)

– Emile Servan-Schreiber (NewsFutures CEO and Co-Founder)

– Brian Shiau (The Sim Exchange CEO and Founder)

– Adam Siegel (Inkling Markets CEO and Co-Founder)

– Ashish Singal (Capital Markets Professional)

– Erik Snowberg (Assistant Professor of Economics and Political Science at California Institute of Technology)

– Brad Stewart (Reality Markets Founder)

– Brent Stinski (Media Predict CEO and Founder)

– Karim Tahawi (MyCurrency Founder)

– Jason Trost (Co-Founder of Smarkets)

– George Tziralis (Doctoral Researcher at National Technical University of Athens, Co-Founder of AskMarkets)

– Robert Wilburn (Rimdex CEO and Founder)

– Gerry Wilson (YooNew CEO and Co-Founder)

– Justin Wolfers (Professor of Business and Public Policy at the University of Pennsylvania)

– Matt Youill (Chief Technologist at Betfair)

– David Yu (BetFair CEO, Former CTO and COO of BetFair)

– Eric Zitzewitz (Professor of Economics at Dartmouth College)

– Plus, many, many more&#8230-

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Other Prediction Market People At LinkedIn

– Russell Andersson (Chief Operating Officer, Third Ave Beach)

– Paul Architzel (Counsel at Alston &amp- Bird)

– Adrian Asher (Global Head of Security at BetFair)

– Henry Berg (Group Manager on Information Markets at Microsoft)

– Matt Carter (Director of the Advanced Technology Group at BetFair)

– Alexander Costakis (Managing Director of Hollywood Stock Exchange)

– Jonathan Cumberlege (Former Director of Registrations &amp- Payments at BetFair)

– Mark Davies (Managing Director of Corporate Affairs of BetFair)

– Mike Dooley (Vice-President of Engineering at NewsFutures)

– Sean Dunbar (Former Head of Technology at Hollywood Stock Exchange)

– Mathias Entenmann (Exchange Managing Director of BetFair)

– Brian Galebach (Freelance Computer Programmer and Owner of Probability Sports)

– Carol Gebert (Former Founder at Incentive Markets)

– Christian Hellmers (Director of US Business Development of BetFair)

– David Jack (TradeFair Director)

– Nicholas Jenkins (Owner of Betcha.com)

– Ajit Kambil (Global Director at Deloitte Research)

– Alam Kasenally (Xpree CTO)

– Dawn Tevekelian Keller (Director, Services Business Group &amp- Prediction Markets at Best Buy)

– Amy Lamare (Former Operations and Content at the Hollywood Stock Exchange)

– Heidi Levin (Director of Business Development at Inkling Markets)

– Robin Marks (Head of Media at BetFair)

– Hunter Morris (Co-Founder of Smarkets)

– George Neumann (Professor of Economics And Applied Mathematics and Computational Sciences at the University of Iowa, Co-Founder of the Iowa Electronic Markets)

– Sean Park (Founding Partner at Sixth Paradigm)

– Todd Proebsting (Director at Microsoft, Former Group Manager on Information Markets at Microsoft)

– Don Reynolds (Site Administrator at NewsFutures)

– Felix Salmon (Financial Journalist at Portfolio)

– Bimal Shah (Product Manager at TradeFair)

– Martin Spann (Professor at the University of Passau)

– Will Speck (Director Business Development &amp- Market Research at Financial Times &amp- FT.com)

– Martin Thompson (Engineering Director at TradeFair)

– Geoffrey Tso (Engineering Manager at Xpree)

– Andrew Twaits (Corporate and Business Affairs Director of BetFair Australia)

– Mark Wood (Head of Programme at TradeFair0

– Plus, many, many more&#8230-

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3. FaceBook Network

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Chris Masse&#8217-s network at FaceBook.

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Our Prediction Market People

– Maurice Balick

– Caveat Bettor

– Bo Cowgill

– Nigel Eccles

– Mat Fogarty

– Robin Hanson

– Tim Harford

– Panos Ipeirotis

– Max Keiser

– Greg Knaddison

– Mike Linksvayer

– Chris. F. Masse

– David Pennock

– Marc Rose

– Jason Ruspini

– Emile Servan-Schreiber

– Erik Snowberg

– Jason Trost

– George Tziralis

– Justin Wolfers

– Plus, many, many more&#8230-

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4. Google Network

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– To share feed items with me (Chris Masse) within Google Reader, go to GMail, click on &#8220-Add Contact&#8221-. Paste my e-mail address there (chrisfmasse +++at&#8212- gmail +dot&#8212- com). Once I receive your invite, I&#8217-ll accept it.

– Alternatively, send me your GMail e-mail address, and I will activate the relationship.

– You will then see my shared items and I&#8217-ll see yours within Google Reader.

– Don&#8217-t worry, you can hide me later on, if you don&#8217-t like what I share. Just put your mouse cursor on my name on the list, &#8220-HIDE&#8221- appears, and click on it, and you won&#8217-t hear from me anymore.

– I share only the very good stuff on politics (facts + opinions, but coming from multiple horizons, not only from one camp), information technology, business, marketing, finance, prediction markets, etc.

– Chris Masse&#8217-s Shared Feed Items at Google Reader

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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.)

What is a prediction market? What is the utility of enterprise prediction markets?

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Consensus Point:

First, every market price is a prediction. Think of a familiar securities market such as a stock market. The price of a company’s stock is a forecast of the value of future dividend payments. A bond price is a forecast of the value of a defined set of interest payments, based on factors such as likelihood of default and future inflation. Second, markets generate forecasts in a very specific way – by aggregating and consolidating information from many individuals, often widely dispersed, each with access to small, idiosyncratic bits of relevant information.

This informational structure is very common in organizational life. Information within firms is often widely dispersed and undocumented, residing in the minds of employees. Junior level workers, for example, while perhaps knowing little about the overall set of strategic issues affecting their company, often have detailed understandings of isolated aspects of the business.

The fundamental challenges of corporate forecasting are to access and coordinate all relevant bits of information dispersed throughout a company and to consolidate them into a set of quantitative metrics that can be employed as forecasts.

But organizations impose significant constraints on the flow and processing of information. The hierarchy that defines organizational life often restricts the movement of information, from the bottom-up as well as across business units, and sometimes, because of various forms of “politics,” motivates the concealing of information or even the spreading of disinformation. When combined with well-documented effects such as human limitations in expressing complex thoughts and systematic biases in group decision-making, the result is that employees often do not reveal their honest assessments, sometimes because they’re not provided the opportunity and sometimes because they fear reprisal for offering an unpopular opinion. Forecast quality suffers.

Prediction markets offer firms the opportunity to incorporate the information aggregating and predictive power of markets within corporate structures relying primarily on top-down direction. A prediction market is established within a company to generate predictions on issues of interest to managers in a manner that directly addresses the foundational communication constraints within firms.

A “stock” is defined to reflect an issue of interest to managers, perhaps unit sales of a product over a specified future time period. A group of employees – perhaps salespeople and marketing personnel -are selected to participate as traders on the basis of their perceived understanding of future sales prospects. Using software that is commercially available and run as an internet (or intranet) application, the participating employees are provided trading accounts, the stock is assigned an initial value (perhaps reflecting management’s current expectation of sales in the defined period) and a currency is established to provide a medium for exchange.

With the protection of anonymity (eliminating the fear of reprisals for offering unpopular opinions) and a well-defined incentive structure, employees are motivated to acquire relevant information and contribute their best assessments. They buy and sell shares of the security based on their beliefs about future sales prospects and their desire to increase the value of their portfolio. When an employee, for example, observes that the price of the stock is less (or more) than his/her expectation of future sales, he/she will buy (or sell) the stock, thereby driving its price up (or down).

As a result of this dynamic, the stock price serves as an ongoing real-time forecast of future sales. It continuously reflects traders’ aggregated assessment of future sales of the product, in the same way that the trading of a company’s stock on a stock exchange continuously reflects the trading community’s collective assessment of the value of the company.

Several internet-based prediction markets have been functioning for many years, and many companies have implemented prediction markets internally. Performance comparisons reveal that such markets produce forecasts that are more accurate than those from traditional systems.

Prediction markets not only produce forecasts and assessments that are, on average, more accurate than those produced from traditional forecasting approaches at any point in time (because they incorporate more information and less disinformation), but also, because the markets function continuously, will reveal the impacts of new information far faster than any alternative approach. Because the usual disincentives for employees to reveal bad news to managers have been eliminated, this system can in some instances serve as an effective “early warning system.”

The informational content of a prediction market is not limited to the stock price. The underlying bid data can be examined for insights into the knowledge and the beliefs of specific employees and groups within the organization. Analysis of market transactions in prediction markets will identify areas where there is substantial disagreement among employees about future values of key parameters driving the firm’s strategic decisions. Such disagreement, reflecting a collective uncertainty about underlying factual premises and/or interpretations, will highlight areas where the incremental value of additional managerial attention, in the form of information gathering (including perhaps discussion with select employees) and/or analysis, will be particularly high.

There are additional benefits of prediction markets – such as improved decision-making on personnel issues and improved employee morale – that can be realized with the most force when the markets are employed for long time horizons.

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Thanks to David Perry of Consensus Point for allowing me to republish this explainer.

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Robin Hanson is now Chief Scientist of Consensus Point.

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Robin Hanson is now Chief Scientist of Consensus Point.

Here&#8217-s the expanded list of Consensus Point customers &#8212-Fortune-500 firms, mainly.

Here&#8217-s their definition of what is a prediction market.

Here&#8217-s their product page.

With Inkling Markets and NewsFutures, Consensus Point is the co-leader in the enterprise prediction markets space.

Best wishes to all of them.

Transparency is an Imperative, but so are Speed, Access and Understanding.

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InTrade:

Transparency is an Imperative, but so are Speed, Access and Understanding

Tuesday, Oct 14, 2008

TRANSPARENCY IS AN IMPERATIVE, BUT SO ARE SPEED, ACCESS AND UNDERSTANDING
Prediction Markets Have a Big Role to Play

Historic volatility, unprecedented coordinated bailouts, nationalizations, and bankruptcies of some of the doyennes of the financial elite are just some of the new realities we are all faced with.

Many may well be impressed with the speed and scope of the response to this crisis. I am, but it seems to me that Intrade and all in the prediction market industry have an increased obligation and opportunity to contribute to solutions in avoiding future crises.

Since Enron, WorldCom, Tyco et al and again since this crisis ignited we are being told that maximum transparency, disclosure, and better risk management tools are the answer. These solutions are exactly what prediction markets look to and can deliver.

But is something really transparent if it is buried within a 200 page document or if you need a degree in accounting to decipher it? Likewise, if the costs of producing or gaining access to the information is such that only a few benefit, is that maximum transparency and disclosure?

The Sarbanes-Oxley Act (SOX) introduced after the Enron / WorldCom debacles is considered a success by most. However, in light of recent events and comments from Henry Paulson, John Thain and even former AIG chief Hank Greenberg, who all believe SOX threatens the US competitive position in the global marketplace, it hardly seems a panacea.

This is where prediction markets can really help now and in the future. We offer real-time aggregated collective intelligence that is easy to access and interpret. E.g. recession, tax rates, unemployment, offshore drilling, OPEC actions, bank failures, etc. Prediction markets provide a single number &#8212- the probability or risk of something happening. Right now there seems to be a 75% probability that the US will be in recession in 2009.

To get the best predictive information barriers to entry for participants and providers must fall so that adoption and diversity can grow. To contribute their maximum to society (which we expect will befit Intrade and other leaders in our industry) prediction markets need to be embraced, encouraged, and considered part of a solution to managing risks and change. Only when this happens will there be such diversity and adoption that the markets can reach their full potential in aggregating information on the most important issues.

In addition to new and revised regulations, the time is right for expanded coverage of those regulations to include prediction markets and the innovative solutions they offer. If ever there was a time to embrace innovative solutions for assessing and managing risk it seems that time came before I started to write this short note.

Prediction markets are far from perfect, but they typically deliver incentivized real-time, efficient, aggregated probability estimates on uncertain future risks and events. They have never had a more important role and potential than right now.

I welcome your comments.

John Delaney

CEO

Intrade

[email protected]

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Previously: What John Delaney told the CFTC.

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