Jed Christiansen:

It’s obvious that John wants InTrade to be much more successful than it has been, but he still clearly believes that InTrade can still be very successful. He mentioned that one key in their business is market makers- a few of their former market makers left, and that had a significant impact in the categories in which they participated. The new gambling laws in the US has had a significant impact on their business, but John is optimistic about the long-term potential of the industry in the States.

Regarding InTrade and TradeSports, John was clear that the companies are separate legal entities, with different management and employees. That said, he said that like a divorce, there are still connections between the two that take some time to replace. They are also looking into ways that individuals can submit contracts to trade on the exchange, similar to what you can do at Inkling. Clearly this would still be fairly tightly controlled, and judgement of the contracts would be done outside of InTrade by an independent entity.

John is disappointed that InTrade hasn’t grown more than they have. At the same time, he seems to be very optimistic about InTrade because their employees are still very motivated and morale continues to be strong. He also said he would fly to the US, but it would need to be for a good reason.

Finally, John addressed the infamous North Korea missile market. He was asked, “Was it a mistake?” He said both No and Yes. It wasn’t a mistake in that the market was judged according to a strict interpretation of the rules. At the same time, it was a mistake in that they didn’t handle the PR issue particularly well. His lesson learned was that they simply need to be incredibly careful regarding their market definitions.

On that last point, being the courageous web journalist at the center of this NKM storm, let me say this:

1. It was a mistake to state in the contract that the (only) expiry source was to be the US DOD. The Military&#8217-s vocation is not to tell the truth, but to protect the US citizens &#8212-by way of lying, sometimes, if needed. (And we know now that, in all matters related to North Korea, the US DOD&#8217-s policy is to abstain from making public, precise, detailed comments.) Any event futures contract should state that the prediction exchange (betting exchange) will make any effort to gather the facts (i.e., the truth) &#8212-by all means possible (official source of information, the media, direct investigation, etc.).
2. It was a mistake not to void all bets and all trading, or not to compensate the victims (the traders who did correctly predict that a missile would be fired, and lost their money due to &#8220-a strict interpretation of the rules&#8221-), when it became clear that the US DOD was not telling the truth completely (that is, they didn&#8217-t hand out all the details needed by InTrade-TradeSports to expire the prediction market on the &#8220-yes&#8221- side).
3. It was a mistake to retaliate against Chris Masse in the purest Irish tradition: suppression of a subside I never asked for- insults sent from anonymous e-mail accounts- rumors spread around saying that Chris Masse is bitter coz he didn&#8217-t get the money he asked for- e-mails sent by a second-tier, phone-booth, vendor conference organizer (paid by Intrade-TradeSports) to my contacts asking them to cut off all links with Chris Masse- etc. All this in vain, since CFM and Midas Oracle remain the two most popular and prestigious resources on prediction markets &#8212-and growing.
4. It is a mistake to come forward with regrets during a small venue, as opposed to make up with disappointed people and traders in popular web publications.

Previously: BetFair seems to say that InTrade-TradeSports’ illegal approach is not the best, on the long term. + InTrade expired the Larry Craig prediction market too early.

– Crowdsourcing The Crystal Ball – by Forbes&#8217-s James Surowiecki – 2007-10-15

[…] So what&#8217-s the catch? Only this: We&#8217-re still not sure how far into the future prediction markets can really look, or whether they&#8217-re going to be able to foresee the kind of world- or business-altering events that Tetlock, for instance, asked his experts about.

So far, prediction markets&#8217- track record has been built on predicting events that will occur in the near future, and where the range of variables that might determine that future is reasonably small and well defined. (Elections, sales forecasts and product launch dates all fall into this category.) But prediction markets haven&#8217-t, for the most part, been used to try to predict things like the fall of the Soviet Union, and so it&#8217-s not clear whether a market would really be able to foresee events that represent a dramatic break with the past, rather than an evolution from it.

This hardly means that prediction markets are of little use: The kind of forecasting problems that these markets are good at are fundamental to any business. Using prediction markets internally should have a beneficial effect on a company&#8217-s bottom line.

But it is fair to say that we don&#8217-t know enough yet to say that prediction markets really solve the crystal-ball problem when it comes to the long-term future. What we need now is to start using prediction markets to ask bigger questions, which will eventually help us understand what the problem with forecasting really is: Is it how we&#8217-re trying to predict the future? Or is it that we&#8217-re trying to predict the future at all?

What do you guys/gals think? I&#8217-d go with the idea that it&#8217-s quite impossible to use prediction markets to forecast the long-term future.

InTrade-TradeSports:

I just want to make a bet – what do I do?
– In this case you may want to go to our Betting Screen. This displays the bets in a format familiar to Sports Book users. On the Betting Screen you can view moneyline or digital odds and choose the amount of money you want to bet. The Betting Screen has a seperate Help section to get you started.

I think an outcome isn&#8217-t going to happen, but you don&#8217-t have the opposite result, what do I do?
– That&#8217-s the beauty of InTrade, to bet against an outcome you simply sell the contract.

But I don&#8217-t own any contracts, how can I sell something I don&#8217-t own?
– InTrade is modeled on a futures exchange. On InTrade when you sell a contract you&#8217-re actually entering into an agreement to sell the contract when it expires. So if you sell at 35 and the contract expires at zero you make 35 points because the contract is worth nothing. However if the contract was worth 100 then you have to pay the difference, in this case 65 points. The value of a point can vary depending on the contract, but for most contracts on InTrade one point is worth $0.10.

Discussions of internal corporate prediction markets have sometimes pointed out that open, anonymous participation can lead to better information flow within the corporation. See, for example, Jed Christiansen’s write-up of the recent Consensus Point conference, particularly his notes on the presentations of Dave Perry and Fortune Elkins.

A lot of business research has been devoted to the topic of communication within an organization. An article from HBS Working Knowledge tries to sum up the current state of research into roadblocks to communication within an organization.

This propensity to maintain silence, a flaw at once personal and organizational, is &#8220-widespread and problematic&#8221- in both the public and the private sectors, says HBS professor Amy Edmondson, who chairs the Doctoral Programs and teaches in the Technology and Operations Management unit.

&#8220-To cite one example, former HBS doctoral student Jim Detert and I interviewed some 200 people of all ranks and functions in a high-tech multinational. We found to a very significant degree that people did not speak up about things they deemed important. Most of those were not &#8216-bad news&#8217- things- to our surprise we found that people were reluctant to voice what they perceived to be good ideas, unless they were extraordinarily confident they would be well-received. And this in a firm that lives and dies by its ideas.&#8221-

Edmondson says this reluctance to speak up stems variously from fears that superiors will not like the idea or that it may appear to criticize the status quo, which most people find reassuringly familiar or dangerous to challenge. Edmondson sums up the mental calculation this way: &#8220-The potential costs to me for speaking out seem reasonably certain and somewhat immediate- the potential benefit to me for speaking out seems rather uncertain and definitely long-range.&#8221-

The article cites HBS professor Max Bazerman to the effect that “within organizations, candor should be rewarded and incentives designed to encourage [it],” though the article does little to elaborate on the idea.

Instead, the article urges business executives to “develop disagreement” and suggests installing “a team at the top where high contention is demanded and rewarded.” During decision-making processes, according to one professor quoted, executives should ask probing questions and insist that managers “present each situation in objective terms, rather than with a positive spin.” The article sums up with, “What&#8217-s required in an organization is honest, thorough, and ongoing self-criticism, which, after all, is at the heart of continuous improvement.”

Part of the problem with the article is that it is exactly the old-style managerial approach that apparently doesn’t work. For how many decades have business executives been told to encourage honest disagreement, to reward challenges to the status quo? Saying “challenge the status quo” is the status quo. If it worked, then information would already always flow smoothly within corporations.

When the thing that stops an employee from speaking up is a mental decision calculus that compares relatively certain and immediate costs to uncertain future gains, as described by Edmonson, “demanding and rewarding high contention” just seems to raise the stakes. Raising the stakes seems like it would be counter-productive.

Maybe contentious meetings aren’t a good approach for eliciting honest revelations. So if what is said about prediction markets is true – if they can help information be gathered and processed in cases in which traditional ways of gathering and processing information fail – then they can be wonderful things. What was the example that Christiansen cited (from Perry’s presentation), a “forecasting team was trading against their official forecast”? That example shows information flowing more smoothly through prediction markets than through traditional channels.

The article hints at some of the reasons that prediction markets can improve information flow. With private, anonymous trading, the choice to disclose information via the market dramatically revises the mental decision calculus involved. The trader is rewarded if right and penalized if wrong, but in either case the disclosure and net reward is a private matter rather than social event. (At least until you brag about it around the water cooler.)

As the article said, candor should be rewarded and incentives designed to encourage it. Prediction markets provide incentives for candor. Not only that, but over time the traders with useful candor are encouraged by accumulated gains, while blowhards find their accounts diminished.

It is true that prediction market prices present relatively limited signals. Prices may go up or down, but they never say why. But with a signal, at least someone knows to start asking “why” and that is better than not knowing.

[Cross posted at Knowledge Problem.]

One question that often comes up is how to encourage participation in long-term, multi-year event markets. This issue is closely linked to cost of capital, and even play-money markets have opportunity costs and discount rates.

If the outcome is revealed gradually, as with questions about the global climate, offering a series of short-term levered contracts should help. This is not entirely satisfying though because it could be viewed as just increasing the noise in traders&#8217- p&amp-l &#8212- although the traders with correct long-term views will do well, and the greater magnitude of the p&amp-l will attract more traders and keep them interested in the market.

There is just no way to settle a contract today for an event that will happen tomorrow. The most important thing you can do is to minimize the capital required to be committed to the distant event. For instance, traders may be compelled to only post or freeze a fraction of their worst-case loss, although this gets tricky if the contract will likely be resolved in a sudden, drastic jump. In this respect, questions about the climate are more tractable than ones concerning technological breakthroughs, for example. In many cases it may be better to use index futures instead of a binary options.

Most importantly perhaps, remember that most of what &#8220-prediction&#8221- markets do is just aggregating and discounting current information. Therefore ask yourself if anyone feasibly possesses information pertinent to the distant event. There may be nothing to aggregate. It may still be worthwhile to set-up a market because you&#8217-re not sure when someone will learn something relevant, but it is probably undesirable to try to force participation, even for very important questions.

Read the previous blog posts by Jason Ruspini:

• 2009 tax futures yielding 1.5%
• Intrade, with carry
• Talking tax futures on BNN, Canada’s business channel
• Tax Futures, “In Real Life”
• How to sell art short
• YooNew, fears and hopes
• Policy Event Derivatives

Another play money arbitrage explanation, much easier than the last one.

I sat down to the computer this morning at exactly the time emails were arriving from Media Predict announcing the opening of five new markets for the &#8220-Project Publish&#8221- finalists. One of the five finalists will receive a book deal.

In the prediction markets, five new shares were launched at $50 ($ = Media Predict play money). Shares held in the winning book will be paid $100, the others will expire at $0. So, at market launch, selling one each of the five shares would gain $250, and guarantee a payoff of $-100. Result: riskless profit of $150. The market should have launched at $20 each (or, at least, that is one set of prices that would have eliminated the riskless arbitrage opportunity).

First to the new markets, I sold short what I could afford across the board, bringing all the prices down to $35. An hour or two later prices had drifted up on several shares, no doubt due to the enthusiasm some trader had developed for the books, but in their enthusiasm they didn’t realize that they should complement a purchase of one share with sales of other shares – otherwise they leave free arbitrage opportunities in the market. A bit later someone came along and sold all of the share prices down to $20 each.

Now, several hours later, prices have moved much higher on three of the books, while two seem to be drifting lower. I’ve sold some other Media Predict holdings so I could arbitrage some more, but I’m credit constrained in the Media Predict economy so I can’t grab all of the riskless profit. As I write, the current gain from selling a one-of-each suite of shares is $156, so the present riskless profit available is $56.

While the book shares are presented as five parallel markets, actually we have a single multi-outcome market. There are five books, and only one of the five will be selected. Since the sum of the probabilities across the five books is constant, if you think option A is more likely to win then it must be the case that the joint probability of B, C, D, and E is less likely. The market can take advantage of that relationship to improve market performance, for reasons that Chris Hibbert explains in “Increasing Liquidity in Multi-Outcome Claims.” If the market won’t do it, arbitrageurs can.

Note: Chris Masse was puzzled about bigger picture issues in his earlier post on Media Predict, and I comment on some of those issues in response. For the purposes of the post above I’m ignoring the big picture and just wondering about the market mechanism and implementation.