Call it Occam&#8217-s razor, minimization of information entropy, or just KISS principle. Call it &#8216-less is more&#8216-, usability or just common sense.

The question is, are the currently available prediction markets web services compliant with the era of attention economics? Are we able to attract a critical mass of users, thereby surpassing the tipping point needed to turn the mechanism of markets to a typical decision support and forecasting tool?

If a picture is worth a thousand words and assuming that a website&#8217-s source code is an unbiased descriptor of its complexity, I attempted to take a look at the homepages of some popular prediction markets web services, using this &#8216-websites as graphs&#8216- tool. In the results that follow, each cycle represents an html tag.

• intrade

• hsx

• newsfutures

• thewsx.com (by consensus point)

• buzz game of yahoo, a source of inspiration to me

• my beloved inkling markets

• our approach at askmarkets.com (yet in alpha version)

P.S.: I didn&#8217-t include betfair because the graph occurred wasn&#8217-t descriptive of the true complexity of their homepage.

Cross-posted by gtziralis.com.

Despite what you may have read elsewhere, the probability of a fed funds rate cut has increased significantly over the last few weeks.

Felix Salmon and Barry Ritholtz seemed to find more merit in this analysis from WSJ Real Time Economics than I did.

Since the stock market began to sink a week ago, the federal funds rate for next January, as implied by futures markets, has plummeted to 5% from 5.2%. As a result, the implied odds of a quarter-point rate cut from the current 5.25% are said to have risen from 20% to 100%.

Well, nobody in their right mind would ever describe the odds as 100%, but let us not get diverted.

Lou Crandall, chief economist at Wrightson Associates, says while such action is commonly attributed to increased expectations of a Federal Reserve rate cut, that would be a mistake. The real reason, he said, is that investors are fleeing risk and seeking safety in Treasury bonds and bills and other high-quality paper, sending their prices up and yields down. As a result, the entire yield curve has shifted down. To maintain parity with that lower yield curve, the implied federal funds rate also has to drop, he says.

Mr. Crandall says, &#8220-99% of the universe, including a lot of people in those trades, don&#8217-t do it because they think the Fed will ease but because that&#8217-s the way the yield curve is shaped.&#8221-

But wait a minute: isn&#8217-t that a violation of efficient markets? If fed funds futures were out of line with a realistic expectation of Fed action, couldn&#8217-t smart people take positions in the mispriced futures and make a bundle six months later when it turns out the Fed didn&#8217-t cut rates? And shouldn&#8217-t such arbitrage push expectations of the Fed and pricing of futures back into line?

No, says Mr. Crandall, for two reasons. First, the Fed has gotten more predictable but gives no guarantees on where rates will go, so there is no assured profit on such a trade (so it wouldn&#8217-t really be arbitrage). Second, &#8220-The amount of money backing people who have opinions about where the Fed will be in six or nine months is dwarfed by the amount of real money being invested in short-term credit markets.&#8221- Nervous investors are willing to accept a lower yield than what might ordinarily be justified based on the economics in exchange &#8220-for safety. Market participants know that perfectly well. That&#8217-s why it&#8217-s called a flight to quality.&#8221-

The first odd thing about this statement is that it seems to suggest that there are two competing theories of how fed funds contracts get priced. The first theory evidently claims that the contracts reflect investors&#8217- expectations of Fed actions, and a second, supposedly contradictory theory claims that the contracts just follow the Treasury yield curve, as if we have to choose whether the fed funds futures contracts are priced in a way that is consistent with expectations of what the Fed is going to do or if instead they are priced in a way that is consistent with the yield curve.

But of course the answer is that they are priced in a way that is consistent with both. These and every other financial market are responding to exactly the same news that we&#8217-ve been discussing here, and drawing the same conclusions as we have. The latest economic news points to a considerably higher likelihood of economic softness, a situation in which the Fed will want to lower the funds rate and short-term interest rates will come down. That scenario is priced in the fed funds futures, in the term structure of Treasuries, in the stock market, in foreign exchange, and what not. Here&#8217-s what&#8217-s been happening over the last few weeks to the price of the November fed funds futures contract, the simple-minded interpretation of which (and the one that I favor) is that the expected fed funds rate for November has now fallen to 5%.

A second idea in the statement quoted above is the suggestion that one needs to add a significant risk premium to that fed funds futures calculation in order to arrive at the objective expectation of what the fed funds rate will be. It is true that risk premia play a role in the Treasury term structure, and fed funds futures should incorporate that same risk premia. A recent paper by Monika Piazzesi and Eric Swanson finds some indication that risk premia may play a role in longer-horizon fed funds contracts. But evidence for significant risk premia operating in very short-horizon fed funds contracts is much harder to find, as indeed theory predicts it would be. In recent years the Fed&#8217-s actions have become much easier to predict. As the accuracy of your forecast improves and the time horizon for your forecast gets smaller, the risk premium necessarily shrinks, and the risk premium on something you know with certainty has to be exactly zero. Perhaps Crandall is right that risk premia could be playing some role in the January fed funds futures contracts. But I find this story much less plausible for October or November contracts, and, as the figure demonstrates, movement in these was quite dramatic this week.

My guess is that we will indeed see a cut in the fed funds rate by the October 30/31 meeting, if not sooner.

The above article is cross-posted from Econbrowser.

Since the launch of the simExchange, stocks and futures contracts have debuted at a price suggested by the submitter of the game with some adjustment by the admins of the simExchange. This price was generally too high or too low, resulting in sharp price moves following the IPO and windfall profits. This is expected as the forecast of an individual inefficiently aggregates information compared against a market. Although many traders have come to expect windfall profits from an IPO (possibly from the irrational exuberance of the 90s tech bubble), this is not how an IPO is supposed to work.

To remedy this problem, the simExchange began the use of an experimental new IPO process to determine the IPO price. We evaluated many IPO processes such as Dutch auctions and Parimutuel Auctions but decided on a Double Call Auction to keep the process simple. A double call auction is how trading on the simExchange has always functioned. The only difference from standard trading is that the automated market maker is turned off.

Price discovery works through traders submitting buy orders at the maximum price they are willing to buy at and submitting sell orders at the minimum price they are willing to sell at. Essentially, traders are posting a range of how well they think the game will sell—a maximum and a minimum.

For a single trader, this range may be very large. They may think a game will sell a minimum of 400,000 copies (40 DKP) and a maximum of 600,000 copies (60 DKP). This would equate to a buy order at 40 DKP and a sell order at 60 DKP. With this player’s orders alone, the bid-ask spread is a very large 20 DKP.

However, a second trader may believe the game will sell at least 500,000 copies (50 DKP) and at most 650,000 copies (65 DKP). The trader’s orders represents a 15 DKP bid-ask spread, but together with the other trader, the best bid is now 50 DKP and the best ask is now 60 DKP. The bid-ask spread is now 10 DKP.

A third trader believes the game may only sell 300,000 copies (30 DKP) with a max of 550,000 copies (55 DKP). The bid-ask spread is now 5 DKP. The order book would look like this:

As more traders submit orders, the bid-ask spread will tighten and converge on a market price. Individually, no one knows what the IPO price should be, but together, traders can narrow the range down substantially. This price range should be the best guess of a fair IPO price as this is where the buyers and sellers meet (the optimists and pessimists for the game’s potential sales). In this IPO process, trades only occur when traders are willing to buy and sell at the same price. Once again, this is no different from normal trading except there is no automated market maker submitting orders.

However, this process has proven to be difficult to understand for many members of the simExchange, especially those who use the Basic Trading mode, which is limited to placing market orders (orders that immediately take the best available price). If a trader is not used to looking at what is the current selling price, he may be in for a surprise when his buy order fills.

Originally we had considered reserving the IPO process only to those using the Advanced Trading interface so that traders are forced to identify the matching price they would accept. However, we thought traders using the Basic Mode should still be allowed to participate if they see a price they think is good for buying or selling. Of course, this assumes the trader using the Basic Trading mode is paying attention to the current bid and ask prices. However, many traders using the Basic Trading mode ended up with prices they were not happy with.

Last night, we have heard a deep debate regarding the IPO process. Our goal is to make accurate forecasts in an entertaining and easy to play process. It appears the experimental IPO process has failed to accomplish those goals for many traders.

Based on user suggestions, we will combine the experimental process with elements of the original IPO process into a 2-step IPO process. Once a stock or future is listed on the simExchange, there will be a stage to determine the IPO price. This will be a three-day period in which players place orders in a double call auction. To participate in the double call auction, the player must specify the maximum price he will buy at or the minimum price he will sell at. After the three-day period, an IPO price will be calculated. At this point, the second stage will occur with the stock or future available for purchase or shorting at the IPO price all day by all traders. Following this day, regular trading with automated market maker will commence.

This article was cross-posted from Discovering an IPO price dated July 26 on The simExchange Official Blog.