In “Is Manipulation Good for a Prediction Market,” Eric Zitzewitz seeks to counter my view that “Deep Pocketed Manipulators are a Prediction Market’s Friend” by suggesting that even if my argument is correct, manipulators still may be a net bad for prediction markets.

I argued that a manipulator ends up subsidizing the participation of informed traders in the market by putting money on uneconomic positions. Eric responded with three reasons that manipulation nonetheless may tend to undermine prediction markets. In brief (and in my words), he said:

1. People have a distaste for behaviors which violate the spirit of the activity.
2. The possibility of manipulation, and therefore a biased indicator, will lead decision makers to rely on less efficient methods for information gathering.
3. Manipulation makes it harder to understand what is happening in the market – manipulation is harder to decode than noise – because the manipulator actively tries to trick the market.

I suspect Eric is right that many people will instinctively oppose manipulation– even when a manipulator&#8217-s actions comply with the explicit rules of the market, the conduct seems to violate the spirit of the enterprise. The manipulators aren&#8217-t betting that they can out predict you, they don&#8217-t care about out-predicting you, they are just using the market in the attempt to buy a signal for which they have a private value. This violation of the spirit of the enterprise probably strikes most people as just wrong.

I think the best response to instinctive opposition to manipulators is &#8220-get over it&#8221-. Hold your nose if you have to, but take as much of the manipulator’s money as you can. (If it troubles you to take advantage of manipulators this way, consider the public good you are doing by imposing a tax on undesirable behavior.)

Another obvious and useful response is to become more skilled at reading market prices, so as to not be readily fooled. In the face of a dramatic price change, consult other exchanges or the prices in related markets in order to gain context. Deploying such sophistication increases the cost and diminishes the usefulness of price manipulation.

The second and third points Eric makes suggests that the possibility of manipulation will reduce the value of prediction markets and lead decision makers to rely on noisier, but less manipulable tools for information gathering. (E.g., use expert forecasts instead of manipulable prediction markets.) In these cases, manipulation leads to real economic losses.

Useful responses here constitute a research program for the academics and market developers: what effects do various rules have on the potential for manipulation? what effects do the rules have on market efficiency? can manipulation be detected by analysis of trading patterns (perhaps something a prediction market could implement itself), or would more extensive investigations be necessary (likely beyond the capacity of a prediction market)?

Prediction markets, when they work well, create something of value: a price that can serve as a useful probability forecast of future events or conditions. If anyone relies on these prices to make decisions of economic significance, that reliance will create incentives for third parties to influence the prices. On these grounds I think the potential for manipulation is inherent in the enterprise.

So what? To some extent the natural balancing effects of the market will tend to counter manipulation, because manipulation provides a subsidy to participation by informed traders, and informed trading counters manipulation. This process is unlikely to be transparent, however, given that manipulation only works if it is disguised. The best response to the residual prospect of manipulation seems to be to resort to informed-rather-than-naive interpretation of prediction market prices, and research into market rules which may enhance usefulness of prediction markets.

The top 10 most active prediction markets at HedgeStreet:

Contracts – Time remaining – Underlaying Delayed Price – Bid – Ask – Last – Change
4PM $100 GBP/USD &gt- 2.0075 4h 13m 2.01370 95.00 100.00 95.00 29%
4PM $100 EUR/USD &gt- 1.3575 4h 13m 1.36240 95.00 100.00 89.00 34%
2:30PM $100 Crude Oil &gt- $70.00 2h 43m 69.67 28.50 35.50 29.50 -65%
2:30PM $100 Crude Oil &gt- $69.00 2h 43m 69.67 95.50 100.00 96.00 -1%
$100 Halliburton EPS &gt- $.56 18 days 0.56 76.50 96.50 81.50 -8%
4PM $100 USD/CHF &gt- 1.2150 4h 13m 1.21145 – 8.00 35.00 12%
2:30PM $100 Crude Oil &gt- $69.50 2h 43m 69.67 77.50 79.00 78.00 -16%
2:30PM $100 Crude Oil &gt- $71.00 2h 43m 69.67 – 5.00 6.00 -77%
1:30PM $100 Gold &gt- $657.50 1h 43m 659.6 87.00 91.00 81.50 234%
4PM $100 EUR/USD &gt- 1.3625 4h 13m 1.36240 52.00 66.00 18.50 64%

Technical Note: EPS = Earnings Per Share

&#8212-

HedgeStreet organizes many EPS prediction markets. Here&#8217-s the contract for the Google EPS event derivative excerpted from the HedgeStreet site:

Google EPS

Summary

Google®1 EPS Binary contracts allow traders to take a particular view on the &#8216-Earnings per Share&#8217- number (EPS) reported by Google, Inc. (&#8221-Google&#8221-) for a specific fiscal calendar quarter. At issue is the quarterly EPS number (defined as the net income per common share of stock, non-diluted basis) released by Google for the relevant fiscal quarter. A list of upcoming release dates can be found by visiting the Google website.

Example

Google EPS &gt- $3.55 (18 Jul 07)
This Binary allows traders to take a position on whether the EPS number reported by Google will be greater than $3.55 on July 19, 2007.

Asset
&#8220-Google EPS&#8221- specifies that the underlying for this Binary is the quarterly EPS reported by Google (in US dollars).

Strike Price
&#8220-$3.55&#8243- specifies that payout for this Binary is based solely on quarterly EPS for Google reported on the settlement date is greater than $3.55.

Last Trading Day
&#8220-(18 Jul 07)&#8221- specifies that this Binary will last trade on July 18, 2007.

Position
Buy if you think the quarterly EPS for Google reported in the company&#8217-s earnings release on July 19, 2007 will be greater than $3.55.

Sell if you think the quarterly EPS for Google reported in the company&#8217-s earnings release on July 19, 2007 will be less than or equal to $3.55.

Payout
Buyers make $100 if the quarterly EPS for Google reported in the company&#8217-s earnings release is greater than $3.55 on July 19, 2007.

Sellers make $100 if the quarterly EPS for Google reported in the company&#8217-s earnings release is less than or equal to $3.55 on July 19, 2007.

Definitions

Binary Name Format
[ASSET][STRIKE PRICE][LAST TRADING DAY][POSITION]

Asset
&#8220-Google EPS&#8221- specifies that the underlying for this Binary is the quarterly EPS reported by Google (in US dollars).

Strike Price
Specifies that the payout for this Binary is based solely on whether the quarterly EPS for Google reported in the company&#8217-s earning&#8217-s release on the settlement date is:

&#8220-&gt- $X&#8221- -greater than a specific level, $X.
&#8220-&lt- $X&#8221- -less than a specific level, $X.
&#8220-$X to $Y&#8221- -greater than or equal to $X and less than or equal to $Y (assuming $X &lt- $Y).
&#8220-= $X&#8221- -equal to a specific level, $X.

Last Trading Day
&#8220-(DD MON YY)&#8221- specifies that this Binary will last trade on a specific date, MON DD, YYYY.

Position
Buy if you think the quarterly EPS for Google reported in the company&#8217-s earnings release on the specified settlement date will be greater than the strike price.

Sell if you think the quarterly EPS for Google reported in the company&#8217-s earnings release on the specified settlement date will be less than or equal to the strike price.

Payout
Buyers make $100 if the quarterly EPS for Google reported in the company&#8217-s earnings release is greater than the strike price on the settlement date.

Sellers make $100 if the quarterly EPS for Google reported in the company&#8217-s earnings release is less than or equal to the strike price on the settlement date.

Trading Conventions

Trading Hours
The regular trading hours for Google EPS Binaries is from 8:00 am (ET) to 4:00 pm (ET). The trading of the Google EPS contract is halted at 4:00 pm (ET) on the last trading date.

Regular Trading Days
Google EPS contracts cannot be traded on their settlement date. Otherwise, listed Google EPS contracts can usually be traded any day HedgeStreet is open (see the HedgeStreet Calendar).

Last Trading Day
Google EPS Binaries will stop trading as of the date listed in the Binary&#8217-s name and the &#8220-At a Glance&#8221- table (right). The usual last trading day for Google EPS Binaries is one business day prior to the date on which Google has scheduled to release its Quarterly EPS for the particular fiscal quarter.

Settlement Date
Google EPS Binaries will settle as of the date listed in the &#8220-At a Glance&#8221- table (right). The usual settlement date for Google EPS Binaries is the day of the scheduled Google earning&#8217-s release. HedgeStreet reserves the right to postpone this settlement date if the release of the expiration value is delayed.

Settlement Time
Google EPS Binaries will settle within an hour of 4:00 pm (ET) on the settlement date.

Expiration Value
The expiration value is the number used to determine the settlement value for this Binary. It is the level of the Quarterly EPS of Google, Inc. (&#8221-Google&#8221-) for a specific fiscal calendar quarter, measured in U.S. dollars, as reported by Google in an 8-K Report filed with the Securities and Exchange Commission (&#8221-SEC&#8221-) or, if no such report is issued, as reported in its Quarterly 10-Q Report or Annual 10-K Report, as applicable, filed with the SEC.

For a detailed summary of the Source Agencies providing the expiration values for all Binaries, please refer to the Settlement Source table.

Settlement Value
The settlement value for Google EPS Binary contracts is either $0 or $100.

Speculative Position Limits
There are currently no Position Limits for Google EPS Binary contracts.

Halted Markets
In the event that any market irregularities are declared by HedgeStreet, trading in this Binary market may be halted. If it is determined by HedgeStreet that the market must be halted for any other reason, an explanation will be posted on HedgeStreet&#8217-s website within a reasonable amount of time but no later than 24 hours after the initiation of the halt.

Addition of New Binaries
To provide as extensive and relevant a market as possible, HedgeStreet may add new Binary offerings frequently and at its sole discretion. In some cases, new Binary offerings may affect the demand (and thus in some cases the liquidity and/or trading price) for existing, related Binaries. Traders should consider this dynamic aspect of HedgeStreet when making trading decisions.

Strategies

You can use Google EPS Binaries to speculate.

Speculate
Speculating involves taking a view on the outcome of an economic event with the hope of making a profit.

-Do you feel you have an insight into the future performance of Google?

-Would you like to speculate based on your belief about whether Google EPS will rise, fall, or remain the same?

Conventional investment markets don&#8217-t provide an opportunity for retail investors to speculate on a firm&#8217-s earnings announcements. Binaries let you invest the amount you choose on either increases or decreases in Google EPS.

FAQ

What is Google?
Google, Inc. (&#8221-Google&#8221-) is an American public corporation, specializing in Internet searching and online advertising. The company&#8217-s products and services are Google.com that offers Google Base, Google Video and YouTube. In addition, the firm&#8217-s offering also include: Gmail, Blogger, Google Docs and Spreadsheets, Google GEO (offering earth and local maps), as well as a plethora of other products. Google was founded in 1998 and is headquartered in Mountain View, California.

What are Earnings per Share?
EPS is the portion of a company&#8217-s profit allocated to each outstanding share of common stock, serving as an indicator of a firm&#8217-s profitability. The Financial Accounting Standards Board (FASB) requires companies&#8217- income statements to report EPS for each of the four major categories of the income statement: continuing operations, discontinued operations, extraordinary items, and net income. EPS for Net Income is calculated as:

(Net Income – Dividends on Preferred Stock)/Weighted Average of Common Shares

Why trade Google EPS?
Earnings results of a public company, including both Earnings per Share (EPS) and Revenue, provide insight into the financial health of such company and provide information on the strength of the industrial segment at large. Earnings results are not themselves securities, although they can influence security prices. There are other key measures of corporate progress, though, as well as other outside macro economic events that also influence the value of a given security. Google EPS Binaries allow traders to speculate on whether Google EPS will increase, decrease, or remain the same (as compared to previous quarter&#8217-s release or various analyst estimates).

What is the Financial Accounting Standards Board (FASB)?
Since 1973, the Financial Accounting Standards Board (FASB) has been the designated organization in the private sector for establishing standards of financial accounting and reporting (US GAAP). They are officially recognized as authoritative by the Securities and Exchange Commission (SEC) as the organization responsible for setting accounting standards for public companies in the U.S. The FASB&#8217-s mission is &#8220-to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors, and users of financial information.&#8221-

What is the Generally Accepted Accounting Principles (GAAP)?
Generally Accepted Accounting Principles refers to a set of accounting principles, standards and procedures that companies use to compile their financial statements set by the FASB. Every country has its own standard accounting practice version of GAAP with standards set by a national governing body. US GAAP is not written in law, although the U.S. Securities and Exchange Commission (SEC) requires that it be followed in financial reporting by publicly-traded companies.

What is the Securities and Exchange Commission (SEC)?
SEC is a U.S. government commission created by Congress to regulate the securities markets, protect investors and monitor corporate takeovers in the U.S. The SEC requires public companies to disclose meaningful financial and other information to the public. This provides a common pool of knowledge for all investors to use to judge for themselves whether to buy, sell, or hold a particular security. The SEC is composed of five commissioners appointed by the U.S. President and approved by the Senate. The SEC is designed to promote full public disclosure and to protect the investing public against fraudulent and manipulative practices in the securities markets.

Where can I find the most recent Google EPS release?
The Google EPS information is released each quarter and available on the Google or SEC website.

What is the Expiration Value?
The Expiration Value is the Quarterly EPS (net, non-diluted) of Google, Inc. (&#8221-Google&#8221-) for a specific fiscal calendar quarter, measured in U.S. dollars, as reported by Google in an 8-K Report filed with the Securities and Exchange Commission (&#8221-SEC&#8221-) or, if no such report is issued, as reported in its Quarterly 10-Q Report or Annual 10-K Report as applicable, filed with the SEC.

Where can I find background information related to this instrument?
For general EPS background information, we recommend the following:

* Investopedia.com: EPS
* Bloomberg.com Earnings

**The data displayed herein represents certain types of contracts offered on HedgeStreet that have an underlying expiration value based on the quarterly Earnings per Share or Revenue of publicly traded companies listed on a national securities exchange. The data is being provided for informational purposes only and should not be the sole information relied upon in making investment decisions. HedgeStreet does not guarantee or make any representation as to the accuracy and completeness of the information provided.

1 Google® is a registered trade mark of Google, Inc. HedgeStreet, Inc. is not affiliated with Google, Inc. and neither Google, Inc., nor its affiliates, sponsor or endorse HedgeStreet, Inc. in any way.

Next: HEDGESTREET: Earnings Per Share Prediction Markets + Merger And Acquisition Prediction Markets

Previous blog posts by Chris F. Masse:

• The CFTC is going to close the comments in 11 days. We have 11 days left to convince the CFTC to accept FOR-PROFIT prediction exchanges, and counter the evil petition organized by the American Enterprise Institute (which has on its payroll Paul Wolfowitz, the bright masterminder of the Iraq war).
• The definitive proof that FOR-PROFIT prediction exchanges (like BetFair and InTrade) are the best organizers of socially valuable prediction markets (like those on global warming and climate change).
• Fairness Doctrine prediction markets
• 2 MILLION TRADES LATER: Inkling’s play-money prediction markets are accurate —too.
• Web Forums on Prediction Markets
• Jason Ruspini will answer SOME of these CFTC questions. — 12 days left, Jason.
• QUIZZ OF THE DAY: Which blog is the most open minded?