Collective Error = Average Individual Error – Prediction Diversity

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The Brain has a comment on Scott Page&#8217-s presentation [PPT file] about his book, The Difference:

One question is whether there is a way to usefully systematize that principle by trader selection or via something other than a strict market such as an (incentivised) weighted average system like HP’s BRAIN. The latter type of system will work better in some domains but in general might be less robust because it constantly runs the danger of being overfit to past trader correlations (or apparent expertise, risk appetites, etc). In general, trader self-selection and self-weighting might be more accurate. If you have some metric of “fundamental” trader similarity like proximity, org chart relations, demographic data – as opposed to past trading correlations only, that might work better in terms of expert-selection/expert-weighting.

The Difference

Previous blog posts by Chris F. Masse:

  • BetFair-TradeFair has won its second Queen’s Award for Enterprise in its eight-year history.
  • Inkling Markets is one of the “Hot Companies To Watch In 2008”, according to Forrester.
  • Plenty of great news coming from Inkling Markets in the coming weeks
  • ??? charity-driven prediction markets OR social issue prediction markets ???
  • That can’t be Nigel Eccles of HubDub.
  • The Marketing Of The Reading Of The Public Prediction Markets = What Robin Hanson has deep trouble with, and what the prediction exchanges (e.g., InTrade-TradeSports, BetFair-TradeFair) haven’t fully computed yet
  • In 2013, Enterprise 2.0 will be a $4.6 billion industry. Good. But they forgot to mind the enterprise prediction markets.

Jason Ruspini was an imprudent and cocky predictor, but, in the end, he is a honest man.

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Jason Ruspini went overboard on BBN TV, claiming his tax futures markets will become InTrade&#8217-s most popular ones in 2009, but he managed to control well his descent to Earth:

[Y]es they have lost a lot of steam and that statement seems overconfident at this point, – or has always [been] for that matter. There was no real follow-through to the apparent trend of the first week or so. Lack of news flow is the main culprit. […]

2009 tax futures yielding 1.5%

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The &#8220-&gt-34&#8243- contracts are being offered at 96. If you discount the possibility of the marginal tax rate for that year being below 34%, this is an annual yield of about 1.5%, after transaction fees. The 2010 &#8220-&gt-34&#8243-s are paying around 1.35% and the 2011s, 1.2%. Buying any of those allows you to sell higher contracts on the ladder at reduced margin, as described before.

A possible trade that stands out on the board is to sell the 2010 &#8220-&gt-36&#8243-s in the high 70s and buy the 2010 &#8220-&gt-38&#8243-s for 50. I don&#8217-t see how a spread of 30 is warranted there, as any legislation that accelerates the Bush tax cuts sunset will likely put the highest marginal rate at 39.6%, higher than 38% at least. That is, I think the market&#8217-s implied probability of the rate ending-up in the 36-38 bin is too high. This trade would make roughly a 39% return on frozen margin, which could be improved to 50% by additionally buying the &#8220-&gt-34&#8243-s at 95. (unannualized)

Intrade, with carry

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For years now, a criticism of Intrade has been its lack of a positive carry in long-term markets. In contrast to regulated futures exchanges, Intrade does not pay out interest on deposits to most traders. While understandable, this discourages liquidity and can skew prices near extremes as future winnings are discounted, exaggerating any favorite/longshot bias.

If carry can be seen as a type of liquidity subsidy, it need not be provided by the exchange. It could be paid by other traders, or passed-on by traders that happen to have interest-bearing accounts. Consider a contract that is set to expire at 100 with certainty at a future date. Offers below 100 then represent a carry payment, and prices in such a market imply something like a discount rate. This is not a true interest payment or discount rate because no funds are being loaned, but in some situations the buyer will gain the benefit of reduced margins on subsequent trades in addition to &#8220-interest&#8221-.

Take the new &#8220-tax futures&#8221-, which are structured as a &#8220-ladder&#8221- of binary options. Currently the lowest rung expires at 100 if the highest marginal tax rate is equal to or greater than 34% and zero if it is less than 34%. The next highest rung pays when the highest marginal rate &gt-= 36%, and so on. Say we add a new rung that pays-off if the rate is greater than 0% and has no transaction fees. This would seem to be a relative certainty, and an offer below 100 represents carry. Furthermore, the buyer of this contract can then sell short higher rungs at reduced margin.

For example, with the 2011 maturity contracts, the current bid/ask on the &#8220-&gt-38&#8243- rung is 85/87.5. If a &#8220-&gt-0&#8243- rung existed and someone sold it for 95, the buyer can then go out and short &#8220-&gt-38%&#8221- at 85 with 10 margin (corresponding to his worst-case scenario of negative tax rates: 85-95!) instead of the usual 15 margin frozen, plus collect the carry of 5 in the &#8220-&gt-0&#8243- contract by maturity. In absolute terms, the margin is only reduced by the unannualized carry of 5, but if the trader is right, he will capture a return on frozen margin of 900% ((85+5)/10-1) instead of 467% (85/15-1).

Likewise, an &#8220-impossible&#8221- contract would subsidize buyers. The 2009 contracts are currently 35 ask for &#8220-&gt-38&#8243-. If a &#8220-&gt-100&#8243- rung existed and someone bought it for 2, the seller could then buy the &#8220-&gt-38&#8243- with 33 margin frozen – a subsidized 203% vs. a regular 186% profit in this case. (The &#8220-sponsor&#8221- is not interested in profiting directly on that trade and so the fact that the government would be owed all winnings if they are a US citizen doesn&#8217-t matter.)

Now it&#8217-s fair to ask why you couldn&#8217-t accomplish the same subsidy by just consistently selling for slightly less than and buying for slightly more than what you judge to be fair value. Aside from the facts that this could widen the bid/ask spread and make prices less reliable, the more explicit carry of the system described above is psychologically reassuring and should lead to more trade. It is very hard to distinguish between a 65% and a 67% chance of the next president being a Democrat – for good reason. How can a trader practically determine if a 2% difference in price is a subsidy? At the same time, the sponsor&#8217-s risk is more defined if they stick to contracts with near-certain payoffs. In many cases the sponsor will also be a market-maker, but this system allows those functions to be decoupled.

It could be argued that the risk-profile of the average Intrade trader is such that they are insensitive to these kinds of incentives because they are generally trying to grow small sums of money by orders of magnitude, as opposed to preserving larger sums. Even if this is an issue, the multiplier effect described above should mitigate it.

A more likely problem with this system is the danger of free-riders taking carry without providing liquidity to the sponsored market. The sponsor could deal with this by only extending small subsidies at any one time and ceasing to do so if he doesn&#8217-t see reciprocation. The fact that frozen margin on the trade earning carry is unfrozen only when an offsetting trade is made on the same ladder also discourages free-riders. The system could somewhat easily unravel though, with the &#8220-discount rate&#8221- collapsing to relatively useless levels. This would not be surprising, especially in the &#8220-&gt-100&#8243- contract, although subsidizing tax short-sellers with the &#8220-&gt-0&#8243- contract is more important in this market.

Remember, this entire idea is meant to work within the technical and legal structures as they exist.

Talking tax futures on BNN, Canadas business channel

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Except for that stupid smirk, not terrible for my first t.v. appearance.

It&#8217-s 23:45 minutes in, here.

Afterwards, I met some of the guys from CNBC&#8217-s Fast Money, who were great. I wouldn&#8217-t mind doing it again.

Taxes are the largest class of risk people dont hedge. Our Jason Ruspini (allied with InTrade) wants to change that.

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Jason Ruspini, interviewed by Bloomberg:

Taxes &#8220-are the largest class of risk people don&#8217-t hedge,&#8221- said Jason Ruspini, a New York hedge fund analyst who established the market, which began trading last week. &#8220-Hopefully this year, with this election, there will be kind of an increased interest in this kind of thing.&#8221- […] &#8220-If Democrats are perceived as having a greater chance to get in the White House these tax contracts will go up,&#8221- said Ruspini, who declined to identify his employer because the market he created isn&#8217-t related to it. &#8220-If McCain is elected they won&#8217-t go up as much.&#8221- […] Right now, the market exists only for the top marginal income tax rate. Ruspini said he plans to have secondary markets based on Social Security taxes and whether Congress can restrain the alternative minimum tax from raising levies on tens of millions of households. […] &#8220-This is such a young field at this point,&#8221- Ruspini said. &#8220-Ten years from now, it&#8217-s going to be a huge market. Whenever you have a contract where there&#8217-s a lot of hedging utility, that tends to be a successful contract in the long run.&#8221- […]

Congrats to Jason.

Go read the whole piece.

Previously: Tax Futures, “In Real Life” – by Jason Ruspini

Tax Futures, In Real Life

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I am very pleased to announce the world&#8217-s first tax futures on Intrade. I thank John Delaney and everyone there for their help and enthusiasm in getting these off the ground.

The contracts will forecast the highest marginal single-filer federal tax rates for 2009, 2010 &amp- 2011. I expect trade to be concentrated in the 2011 contracts, as Bush&#8217-s 2001 tax cuts are scheduled to expire that year, reverting the rate in question from 35% to 39.6%, while the lower bracket rates each increase by 3%. While it is less likely, Congress may also alter the Bush tax cuts for tax years before 2011, but such changes would probably impact 2011 as well.

If reasonable liquidity can be sustained in these markets, I hope that contracts will be added to predict corporate taxes, and other factors that contribute to individual effective tax rates, like the Alternative Minimum Tax and the social security cap. Given the tremendous hedging utility of such markets, maintaining a liquid two-way market might be tricky, although there are some obvious ways for any market-makers to hedge what might become a position more short of taxes than usual.

Please read the last post on &#8220-Policy Event Derivatives&#8221- for some background on the potential benefits of such markets. I should add that while I am confident in their long-term value of making better group decisions and sharing risk, I am sensitive to some foreseeable pathologies, and don&#8217-t want to give the impression of being too cavalier at this point. There are potential problems and side-effects stemming from the use of such markets that will be addressed later.

[Cross-posted from Risk Markets And Politics]

Previous blog posts by Jason Ruspini:

  • My response to the CFTC on event contracts
  • The CFTC safe-harbor option for event markets
  • CFTC regulation and election contracts
  • Asymmetry in Obama nomination market
  • Prediction Markets: Powerful enough to be dangerous?
  • 2009 tax futures yielding 1.5%
  • Intrade, with carry

WordPress is a bit like WikiMedia (the software powering Wikipedia), now.

Two weeks ago, I was seeking a WordPress way to have multiple authors for a post or a page. I found 2 interesting plugins.

  1. The CO-AUTHORS plugin, which does what it says. One specific post or page can be assigned two or more co-author(s) by the blog editor. Very interesting. (I don&#8217-t get why the plugin developer forbids the co-authors to &#8220-edit&#8221- the post/page, though. Mystery, which I will try to clear up with the software architect of this plugin.)
  2. The ROLE MANAGER plugin (not listed in the official WordPress plugin directory), which changes the standard WordPress matrix of roles and capabilities. It can redefine the capabilities of one category of users (i.e., one &#8220-role&#8221-), and can change the capabilities of one individual, but won&#8217-t assign common capabilities on a post/page-by-post/page basis (unlike the CO-AUTHORS plugin). To put it in another way, the ROLE MANAGER plugin can be used to extend (or restrict) the capabilities of the blog authors. Right now, they can only publish a post, not a page. In this instance, they would be allowed to write and edit pages &#8212-without the need for the blog administrator to promote these authors as full editors (which would be tricky since those multiple editors could then edit their peers&#8217- posts &#8211-not acceptable in a big group blog with 71 blog posters).

Very interesting.

On Midas Oracle, one could have:

  • Authors Mike Giberson and Adam Siegel writing together a post on &#8220-How Great An Exchange Inkling Markets Is&#8220-.
  • Authors Chris Masse, Mike Giberson, David Pennock and Jason Ruspini writing together a page on &#8220-The Ultimate Prediction Market Definition&#8220-.
  • Etc., etc., etc.
  • If plenty of co-authors collaborate on a post/page, then my hope is that Midas Oracle could become more than just a &#8220-blog&#8221-, and be also a vertical encyclopedia on prediction markets. (Of course, participation inequality remains an issue.)

[External Reading: For the life of you, don’t miss this blog post by Tim O’Reilly on Wikipedia.]


UPDATE: The creator of the CO-AUTHORS plugin writes back to me:

Not allowing all of the co-authors the ability to edit a page is not by design- I just have to do more research on WordPress permissions to find out how to do so, if even it is possible.

I wonder whether using the two plugins together is the solution&#8230-


UPDATE: My current thought is to give each Midas Oracle author the capability to create, write up and edit his/her own page(s). And then to assign co-authors to some post(s) and page(s), on a case-by-case basis.

Red Monitor – Prognostic Exchange

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Red Monitor &#8211- Die 7&#215-24 Prognoseborse &#8211- German-speaking, Austria-based, real-money prediction exchange –

Globaler Marktplatz fur Prognosen.

Actually, the ABOUT US page is in German, only. Hubertus Hofkirchner (CEO) has provided the following information &#8212-the final wording is mine:

Like HedgeStreet, Red Monitor chose the regulated path and is subject to the Austrian Finanzmarktaufsicht supervision. Red Monitor lives off a small fee on traders&#8217-s profits. Red Monitor&#8217-s market design is original and patented &#8212-and scientific and private use is free.

Hubertus Hofkirchner has written a short essay in English to describe the new market design used by Red Monitor, and how it is better than CDA &#8212-or so he says. I leave the commentary to the specialists.

I&#8217-m more interested in one marketing point: Wouldn&#8217-t it make sense to have an English-speaking platform so as to attract international traders? Is Red Monitor restricted to Austrians and Germans?

If Hubertus Hofkirchner wants to leave a comment below, I&#8217-ll be happy to pass the information. He can cross-post his text here, at Midas Oracle, if he wishes.

Also, I know some of the German beta traders. If they want to pass some tips to me, I&#8217-m all ears. One of my source said that the Red Monitor&#8217-s frontpage looks like a stock exchange portal. Indeed. So my next question is (as I can&#8217-t read German, alas): Is Red Monitor in the content business, too?


Full list of English-speaking prediction exchanges at CFM



Hubertus Hofkirchner (Red Monitor CEO) has posted a comment&#8230-

Hello Chris,

Just a short note in reply to your questions following our Public-Beta launch.

“Better than CDA” — is a bit strong because there are many dimensions on which one could compare market mechanisms. There are however quite a few differences to conventional mechanisms some of which may well prove highly advantageous. I will list a few (not exhaustive):

1. The RED mechanism can capture and mathematically measure “price information”.
2. RED, as a market place, monetizes “price information” for those who have or need it.
3. The creation of predictive information &#8211- in principle &#8211- does not depend on liquidity.
4. RED distinguishes between two types of risk, one measured by volatility and one by yield (the Price of Uncertainty).
5. RED’s RealPrice data set provides new methods to identify price distortions of all kinds.

“English” – “Restricted to Austrians and Germans” – Redmonitor’s underlying platform is designed to support multi-language and multi-currency operations, in principle. As you can imagine there are many tasks which must be done before we can activate these capabilities. We will announce other languages and operating constituencies outside the European Community as and when available, so bear with us.


Best regards,
Hubertus Hofkirchner
Red Monitor


And check Jason Ruspini&#8217-s comment&#8230-

From what I can gather, the RED mechanism has more in common with traditional options than the prediction markets we would recognize. […]