Ubber finance blogger Barry Ritholtz believes in magic. He believes that, with more volumes on the event derivative markets, comes the Omniscience -capital O.

No Gravatar

Our good friend Barry Ritholtz.has persuaded himself that our real-money prediction markets suffer from an irremediable and fatal problem: liquidity on political event derivative markets is too thin for smart Wall Street people like him to take their market-generated probabilities seriously. Barry Ritholtz is keen to tout oranges&#8211-apples comparisons: the NYSE volume versus the Obama&#8211-Clinton volume at InTrade. It&#8217-s a bullshit argument, but he managed to persuade some gullible journalists writing for some clueless mainstream media that thin liquidity was responsible for the New Hampshire upset &#8212-and else.

Barry, if you had 1,000,000,000 trades on the New Hampshire prediction market, you&#8217-d still have an inaccurate prediction. The polls were wrong, and there&#8217-s nothing &#8230- NOTHING&#8230- that the InTrade and BetFair traders could have done to get this election right. Get over it, Barry. Traders are not magicians. :-D

[For why the polls were wrong, see: The New York Times, Zogby, Rasmussen, Gallup…]

Prediction Markets 101 – Chapter One: Interpreting The Probabilistic Predictions


Probabilities, Prediction Markets, and Popular Fallacies

With Hillary&#8217-s surprise victory over Obama in the New Hampshire primary, pundits everywhere are decrying the allegedly &#8216-wrong&#8217- odds that prediction markets like Intrade were displaying prior to the announced results. (As just one example, Barry Ritholtz weighs in with his &#8216-explanation&#8217- of : &#8220-Why Opinion Markets Fail&#8220-.)

At one point the betting markets were implying over a 90% probability for Obama to win. Does this mean they were &#8216-wrong&#8217-? No it does not. It is impossible to judge whether a given probability is/was correct based on the outcome of a single event.

A 90% probability simply implies that, if you encounter a series of events each with a 90% probability, then 9 times out of 10, the favored outcome will occur- and 1 time out of 10, the unfavored outcome will occur. Those like Ritholtz who are now calling the prediction markets &#8216-wrong&#8217- are implying the following: if the probability is 90% for an outcome to occur, then that outcome should occur every time. In other words, if the odds are 90% in favor of something &#8212- it should happen 100% of the time! But this is obviously fallacious. If the outcome occurs 100% of the time, then the correct probability to assign to it would be 100% &#8212- not 90%.

To validly assess the accuracy of prediction markets, one needs to aggregate all the situations where the odds were 90%, and then calculate whether the favored outcome indeed occurred 90% of the time. (And do the same with each level of probability.) This &#8212- and only this &#8212- will tell you how accurate prediction markets tend to be.

Barry Ritholtz:

As every good prognosticator knows, if you couch your forecasts in probabilities, the innumeric will never know you were wrong. It&#8217-s a cheap trick for the easily fooled.

Imagine if instead of a &#8220-THE END IS NEAR&#8221- sign, every loon carried a sign that proclaimed:


The fact that this didn&#8217-t happen &#8212- and the 43% probability did &#8212- doesn&#8217-t mean this forecast was accurate. It merely meant that the person had proferred two possibilities and one of those two occurred. But the math remains unverified.

Neat trick: By your definition, PREDICTION MARKETS CAN NEVER BE WRONG, so long as they maintain a 1% possibility of the alternative outcome.

That&#8217-s hardly a satisfying defense&#8230-

Author Profile&nbsp-Editor and Publisher of Midas Oracle .ORG .NET .COM &#8212- Chris Masse&#8217-s mugshot &#8212- Contact Chris Masse &#8212- Chris Masse&#8217-s LinkedIn profile &#8212- Chris Masse&#8217-s FaceBook profile &#8212- Chris Masse&#8217-s Google profile &#8212- Sophia-Antipolis, France, E.U. Read more from this author&#8230-

Read the previous blog posts by Chris. F. Masse:

  • Good news: The BetFair blog now features a prediction market column. — Bad news: Their columnist is an anonymous writer with long hair… and dubious skills.
  • Once again, a BetFair spin doctor misunderstands the prediction market approach.
  • Grandizer
  • Tss… Tss… Surely, you are joking Doctor Giberson.
  • Comments are still open on Midas Oracle.
  • “I am much more aligned with InTrade than you are, Chris.”
  • And the award for the most technology advanced software vendor goes to… the envelope, please…. QMARKETS in Israel. … [Cheers and applauses in the crowd.]


No Gravatar

Silicon Alley&#8217-s Jonathan Kennedy:

[…] In denouncing prediction markets as &#8220-wrong,&#8221- however, many pundits miss the point. Prediction markets do not provide accurate predictions of the future. (How could they? They simply represent the consensus guess of a group of people who aren&#8217-t prophets). They merely provide the most-informed guess as to what that future is likely to be.

As numerous &#8220-collective wisdom&#8221- studies have shown, the consensus guess is always better than the majority of the individual guesses that are factored into it (not sometimes&#8211-always). The collective wisdom, moreover, is often more accurate than that of ANY individual. Why? Because the market collectively incorporates far more information than is available to any one individual.

Like the stock market, prediction markets don&#8217-t get it right every time. They do, however, provide a useful window into the collective expectations of others&#8211-one that is often the best available estimate of the future. And they do sometimes get it right. Just as they did with Mr. McCain.

Bravo, mister Jonathan Kennedy.


Take that, Barry Ritholtz. :-D

In an upcoming post, we will review the strengths and weaknesses of these thinly traded prediction markets&#8230-

We are holding our breath, Barry. Hurry up.


No Gravatar


Barry Ritholtz:

In an upcoming post, we will review the strengths and weaknesses of these thinly traded prediction markets&#8230-

We are terrified. We&#8217-re pissing in our slip. :-D

Previously: Prediction markets are forecasting tools of convenience that feed on advanced indicators.


UPDATE: Barry Ritholtz comments&#8230-

Never fear the truth, son&#8230- it shall set you free.



UPDATE: Why Prediction Markets Fail – by Barry Ritholtz