Prediction markets didnt revolutionize decision-making -and will never do. However, they are a nice condiment to the classic forecasting toolkit.

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I have spent several hours re-reading the 2004 AEI-Brookings book, &#8220-Information Markets&#8221- (by which they mean &#8220-prediction markets&#8221-). It is a collection of un-enlightening research articles &#8212-except for the IEM article, which is outstanding, both on the factual and theoretical sides.

In the conclusion of their introduction, Robert Hahn and Paul Tetlock wrote that they want their readers to contemplate the idea that prediction markets could make a &#8220-big&#8221- difference and &#8220-revolutionize public- and private-sector decision-making&#8221-. Well, 4 years later, it is clear that those big dreams didn&#8217-t pan out. Not a single mass media outlet has praised the public prediction markets for their work on the 2008 US presidential election (I am taking about a post-mortem analysis about Election Day, not the primaries). Not a single one. (Not even Justin Wolfers.) And the number of corporations using enterprise prediction markets is still minute. The thinkers who wrote this book (&#8220-Information Markets&#8221-) all made the mistake to put the emphasis on accuracy instead of efficiency. That was the foundation flaw. We should reset and reboot the field of prediction markets.

Previously: The truth about prediction markets

Does Liquidity Affect Securities Market Efficiency? – Paul Tetlocks new abstract

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Does Liquidity Affect Securities Market Efficiency? – (PDF – Listed at CFM) – [previous title: Does Noise Trading Affect Securities Market Efficiency?] – by Paul Tetlock – 2006-11-XX

The basic idea of the paper is simple. I measure liquidity and expected returns for various securities, and show that the two are linked. In an efficient market, the benchmark is that all securities should have zero expected returns. I find that the illiquid securities markets have (close to) zero expected returns, implying that these markets are efficient. But the liquid securities show certain mispricing patterns. The nature of these patterns suggests that individuals&#8217- probability misperceptions are the cause of the mispricing in liquid securities.

Note: the zero expected returns benchmark is a simplification. It&#8217-s based on the assumption that the equilibrium price of risk is negligible, which is a good approximation for most securities on TradeSports &#8211-e.g., sports contracts, and most of the short-term financial contracts. Obviously, this assumption would fail in conventional financial markets, where risk premiums may be large.

Previous Blog Posts:

Paul Tetlock on the inner working of TradeSports-InTrade

– No change: Mispricing is greater in illiquid markets + Justin Wolfers&#8217-s comment

– Does Liquidity Affect Securities Market Efficiency?

Short Odds for Ignorance

Gambling and a New Approach to Regulating Information Markets

External Link:

– TradeSports forum thread

Parting Shot:

Yeah, it was the Paul Tetlock festival, today.

No change: Mispricing is greater in illiquid markets.

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Paul Tetlock’s latest paper on the subject of prediction markets “Does Liquidity Affect Securities Markets Efficiency?” follows the lines of the other authors whose model starts with the concept of first generation prediction markets, designed in such a way that their prices express probabilities.

First: We should not be surprised that those markets “underprice high probability events and overprice low probability events”. This is a consequence of continuous information arrival. Any binary option MUST show this behaviour, mathematically, depending on its In-the-money or Out-of-the money state.

In the framework of Price Information Theory, with continuous information arrival, you “lose” probability until the prediction horizon sigma sqrt T of the price differential. No “irrationality” there. (Remember: “Austrians” start on the premise that man is rational.)

Second: The immediate analogy from such binary contracts to behaviour of securities markets is not permissible. Securities markets price discounted future cash-flows in consideration of the two risks (ex-ante volatility and noise) affecting them. Applying the problematic binary framework to securities prices does not make binary options a security, they stay what they are. (Price predictions on rice in China does not make them edible.)

Third: Based on this, it is easy to explain why the conclusions of the paper appear overdrawn: The better the probability of a binary follows the information decay, the more mispricing the presented model would detect. Mr. Tetlock final thoughts appear to run in a similar vein by stating in the end that “…, liquidity may only appear to be a priced risk factor because it captures some systematic element of mispricing.”

So: On this one, let’s stay with the cited conventional models (Kyle) plus some empirical evidence from “real” securities markets: Mispricing is greater in illiquid markets.

Hubertus Hofkirchner

BetFairs Annual Review 2006: How did the worlds #1 real-money prediction exchange (betting exchange) fare in 2005/2006?

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Pretty good, thank you. British betting expert Niall O&#8217-Connor reports that &#8220-Betfair has announced that during the year to 30 April 2006, it recorded year-on-year revenue growth of 35 per cent to ?144.7 million, with profits before tax up to ?37.8 million from ?23.1 million in 2005, an increase of 63 per cent.&#8221-

More information: BetFair site – BetFair Corporate site – BetFair Annual Review 2006 (PDF)

Highlights of BetFair Annual Review (the sub-titles and emphasis are mine):

1. Unlike TradeSports/InTrade, BetFair does not break U.S. laws.

In light of recent events in the United States we continue to monitor the situation. We wish to reiterate our well documented and long-standing policy of not accepting US customers, funds, or bets. For many years, we have followed industry best-practice to ensure that we are able to detect and block unwanted usage.

My Remark: A small number of U.S. residents has managed to open an account with BetFair, I&#8217-ve heard, because they managed to prove some kind of residential or banking U.K. presence.

2. Compared to BetFair, TradeSports/InTrade and HedgeStreet look like kindergarten toys.

The size and scalability of the site is demonstrated by the fact that there were over 1.3 billion bets placed on the exchange in 2005, which is more than all the previous years’ totals added together. We now regularly handle over five million bets per day, serve two billion page impressions a week and more than ?2,000 a minute is deposited onto the site. We now employ over 900 staff across five main offices in West and North London, Denmark, Malta and Australia. While we are beginning to experience economies of scale in many operational areas, we continue to recruit heavily in IT, Product Management and International Development. These new hires will accelerate our product delivery and competitive advantage in the years ahead. Customer numbers are also impressive. In the past year we have doubled the number of registered customers, with over 900,000 by the end of the World Cup. The number of monthly actives increased from 95,000 to over 150,000 by April 2006 […].

My Remark: Two bets make up for one transaction, right?

3. Unlike TradeSports, BetFair has signed agreements with sports bodies.

We continue to work closely with a number of sporting regulators, notably in horseracing, football and tennis, which highlights the importance of our information sharing agreements. A series of &#8216-MoUs&#8217- (Memorandum of Understanding) have been signed with sports bodies over the year, including the Rugby Football Union, Women&#8217-s Tennis Association, International Tennis Federation, Belgian Football Association, British Darts Organisation, Racing Services Tasmania, Racing Victoria Limited and, most importantly in light of the World Cup, FIFA. This brings the total number of agreements we have with sports bodies worldwide to 24.

My Remark: Twenty four. Impressive.

4. Unlike TradeSports, BetFair has applied its trading technology to other applications.

The poker market is particularly competitive and therefore it is important that we expand our product portfolio and diversify our revenue streams. We acquired PokerChamps, a Danish-based poker platform, in October, and from August this year Betfair&#8217-s entire Games portfolio has been hosted from Malta. We will continue to invest and improve the product to make it the most exciting poker offering. The Games offering was also extended with the launch of Exchange Baccarat [CFM: and recently Exchange Hi Lo], complementing exchange versions of Poker and Blackjack. These unique exchange-enabled products offer further opportunities for customers and reinforce our reputation for innovation.

My Remark: I&#8217-m not (yet) persuaded that the BetFair Exchange Games is such a great killer ap. What I see is a small number of existing BetFair traders playing this stuff. In the coming months and years on this blog, I&#8217-m going to elaborate on the X Universes, which is a concept that extent much further. If you&#8217-re a universe creator, a techie, a VC or an exchange manager, stay tuned- the future will be fascinating in this area.

My Question To Robert Hahn And Paul Tetlock: Would your proposal, discussed in your paper and in your New York Times Op&#8217-Ed, allow for one or some U.S.-based real-money prediction exchange(s) as POPULAR AND PROFITABLE as U.K.-based BetFair?

NEXT: The BetFair 2007 Annual Review = 2007 Results (ending April 30, 2007) – (PDF file) –

Previous blog posts by Chris F. Masse:

  • Americans love rankings, but Americans hate to be assessed subjectively.
  • A libertarian view on the Internet betting and gambling industry in the United States of America
  • The CFTC is going to close the comments in 10 days. We have 10 days left to convince the CFTC to accept FOR-PROFIT prediction exchanges (e.g., InTrade USA or BetFair USA), and counter the puritan and sterile petition organized by the American Enterprise Institute (which has on its payroll Paul Wolfowitz, the bright masterminder of the Iraq war).
  • The Numbers Guy
  • The CFTC Readings Of The Day —Thursday Morning Edition
  • 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).

How important will the Unlawful Internet Gambling Enforcement Act be? Markets think pretty important.

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With news that the Unlawful Internet Gambling Enforcement Act has passed the House, all eyes seem glued on Washington to see just how regulation of online gaming is going to change the industry.

Looking at stockmarket reactions, it seems pretty serious.

From today&#8217-s Guardian:

The online gaming industry&#8217-s bet that American legislators would never get around to outlawing internet games such as poker went spectacularly wrong yesterday. An estimated ?4bn was wiped off the sector&#8217-s value as share prices crashed after a weekend ambush by Washington.

Full story:,,1886369,00.html.

I have already heard of at least one major bookmaker – Australian-based Centrebet ( – already closing the accounts of US-based clients.

While these early stock-market reactions look pretty serious, my guess is that these sorts of laws tilt the competitive landscape away from the larger more legitimate operations (like those public companies based in London), and toward the smaller (and more legally &#8220-agile&#8221-) firms operating in a less transparent manner. So perhaps this stockmarket reaction somewhat overstates the impact.

Stay tuned for more&#8230- (Hat tip: Paul Tetlock and Sam Savage.)