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09/14/2008

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Michael F. Martin

Nice summary of prediction markets.

Could you explain what you mean by the following: "bring prices into closer phase with value"? (Perhaps in another entry?) Do you have a theory of how the time required for processing and communication of (even public) information to markets creates temporary shortages and surpluses in market prices. Doesn't this violate the efficient market hypothesis?

neilehat

Excellent! Now we have the "prediction pools" to contend with. In addition to voter fraud, hanging chads pollsters, Radio/TV Talk Show Hosts and the like. Does this really all mean that Dewey defeated Truman? Something in the back of my mind is screaming, "GAMBLER'S FALLACY"!

Michael Hochster

Do the studies which show prediction markets beat polls show that they do so per unit cost of collecting data? It is not so impressive if an expensive prediction market beats a cheap poll which could be made as accurate by spending an equivalent amount on a larger sample size.

Blake

The prediction markets should be fairly cheap, you are playing bookie, and bookies make a profit. Since you want the information and probably have money you most likely would like to subsidize it in the same way a bookie taxes the odds. Also they aren't talking about accuracy like a larger sample size fixes, they are talking about accuracy of results, so it IS impressive if they can get better results even if it costs more money. Cheap wrong info

Matthew

Firstly, I want to say that I am a big proponent of election markets as hedging instruments, but I think their predictive power gets overstated by simple statements like "they have predicted X," since a contract can "claim" different things throughout its long life. I don't follow IEM, but so far in the contract life of the presidential binary on Intrade, both Obama and McCain have traded at >50%, and Hillary has traded at 49% while holding a commanding lead over the field. So, any of these three could win the election, and Intrade in turn can claim to have predicted the results correctly via the free market.

Where we can see that the markets are pricing odds of winning incorrectly is in the arbitrage bounds of the markets, and in these, you can tell there are many failings in these political markets. The most simple one to observe is that there can be at most one winner of the election, so owning all candidates should be worth 100% less the cost of holding that position. However, I have frequently seen the sum of all bids exceed 100% by as much as 10%. Taking a short position in any subset of candidates such that the sum is greater than 100% is arbitrage. (Note: I just pulled up the historical graph of IEM and observed the same phenomenon with their prices on Dems vs Reps rather than bids on people.)

This, to me, indicates that the predictive powers of Intrade are not as strong as statements like "IEM [...] has correctly predicted the outcome of every presidential election since 1988" would indicate. And 10% north of arbitrage indicates the markets could be extremely far off.

Berend de Boer

Mr. Posner, you wrote: One problem with prediction markets, a problem that occurred on the day of the 2004 presidential election, is that a market can swing on the basis of unreliable information until the information is corrected.

Although true, you have to take into account the volume. That wasn't much volume. I and a couple of investors dived in when Bush dropped, but he never got below $33 or so, and there was never a case that we could scoop up as much as we wanted to. And it didn't last that long. But it was the icing on the cake.

Berend de Boer

On my last post: that was on intrade.

Jack

Michael: Not sure if this is the answer you're seeking.........

"Could you explain what you mean by the following: "bring prices into closer phase with value"?"

......... but consider that a product, say a home, does not sell until the value (perceived or actual) is higher than the asking price.

That's how we KNOW, as a study divulged last week, that the oil prices are due to a "market" gone awry, ie. being manipulated. Absent significant shortages the price of a bbl of oil should about the cost of replacing the bbl sold plus a reasonable profit, under the system that has served us for many years.

I guess that brings up a question as to whether we've priced oil correctly in the past by selling it only for production costs plus a small profit. Since no more is being created should oil be sold cheaply enough to burn? or should our government set a higher, intrinsic, price meant to conserve diminishing supplies to be used more sparingly in applications where there are no substitutes?

Pricing oil at higher prices would have the effect of subsidizing all of the alternatives evenly (rather than having pets such as US produced corn ethanol) and draw out the most efficient substitutes to "burn" thus saving our oil to lubricate our windmills and make resins or for other higher value uses.

robert

Judge:
Interesting comment on the "wisdom of crowds" phenomenon. Might it have some relevance to the actions of juries?

Jim

Too bad the economists at Bear Stearns and Lehman Brothers and Merrill and AIG didn't check the prediction markets. Even the pollsters would have gotten it right had they asked, "Do you think that greed and stupidity will have a negative effect in the long run?"

Matt

Would there really be a danger of market manipulation if there were no maximum? It seems unlikely that buying up Iowa prediction shares to change the Iowa price would be the most productive use of campaign funds. Even if there were attempts at market manipulation, there would be plenty of people ready to buy on the other side as soon as the price didn't match the true value of the shares. Any sum of money spent on political campaigns will be insignificant compared to amount people are willing to spend to make an easy profit.

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Robin Hanson

There is an academic literature on price manipulation in prediction markets that, so far, suggests it isn't much of a problem.

Thomason

With all due respect - this is what you write about in the midst of an economic meltsdown?

Michael Caracappa

Judge Posner writes: The Iowa Electronic Market "has correctly predicted the outcome of every presidential election since 1988."


That assertion carries little significance without also stipulating how far in advance the prediction was made. Did the IEM predict the correct outcome a week ahead? A day ahead? An hour ahead? My own impression of the IEM, having followed it for some years, is that IEM predictions border on worthless until the exit polls start coming in on election day. Then, by Golly, it's almost always right on!


That aside, the IEM doesn't really predict. It sets a probability of victory. Today (Sept 17), the IEM gives Obama a 57% probability of winning. So in 100 election "trials," you'd expect Obama to win 57 times and McCain to win 43 times. Therefore, if McCain, with that probability of victory, were to win a particular "trial," IEM wouldn't be wrong. Neither would IEM be right if Obama were to win.

Jim

Each week there is an electronic poll on AOL which is state specific and has an n of about 500,000. While I do not know the exact demographics of AOL users, the site itself is fairly liberal and with a sample that large, there must be some degree of both randomness and central tendency.

The poll has for the last two months shown an overwhelming majority for McCain and no one is wagering. Either it is a total fraud or very accurate. We will soon see which.

Jim

Oops! Here are the demographics for AOL:

AOL Demographics

35 million members worldwide
2.7 million peak simultaneous users
400 million e-mails sent and received daily
13.4 billion Web URLs served daily
70 minutes online per member daily
More than 2.1 billion instant messages sent daily across the AOL network

Gender
Male: 43%
Female: 57%

Marital Status
Single: 38%
Married: 62%

Education
College Grad: + 51%

Age Composition
18-24: 15%
25-34: 18%
35-44: 25%
45-54: 24%
55-64: 12%
65+: 7%

Household Income
$50k+: 63%
$75k+: 40%
$100k+: 23%

Occupation
Professional/Managerial: 30%
Self-employed: 11%

Source:
http://www.aolyellowpages.com/advertisers/1/H_why_demog_aol.htm

neilehat

When it comes to predictions, especially elections I think the best approach can be borrowed from old Leo Deroucher, "it ain't over till it's over". That is, unless of course, the Supreme Court decides too step in and elect Presidents.

Jack

The demographics should explain the McCain bias on the AOL polls. HH Income begins above median so fully half of the nations HH's are left out which would include a large number of young and minorities.

Also, I'd take a small position on predicting that those defining themselves as "conservatives" today would be more prone to "vote" in a voluntary poll.

robert

The Supreme Court did not "elect" anyone. By a 5-4 vote it stopped the recount. But more importantly, by a 7-2 vote the Court found a violation of the Equal Protection clause. You read that correctly: two justices from the minority on the recount joined the majority as to the equal protection violations. Don't believe me? Just Google 'Bush v. Gore'.
And finally, the NY Times (that's right, the NY TIMES!) found, after its own exhaustive investigation, that George W. Bush beat Al Gore in Florida.
Now, neilehat, care to change your name
to "tinfoilehat"?

Handmaiden to the Translational Biomedical Sciences

I think that you are wrong to say that the wisdom of crowds is really just a matter of reducing sampling error, because I think that Galton-type experiments typically show that the average of a large number of individual guesses is better even than the best individual guess. (This was the case with his own original observation of villagers guessing the weight of an ox at a fair, and is also the typical experience of psychology or economics professors recreating the situation by having their students guess the number of marbles in a jar or some such.) Thus, by averaging the guesses, one is not just reducing the chance of landing on a widely-off guess.

neilehat

robert, "Tinfoil" hats huh? Sounds like something out of Tom Terrific. No wonder the World no longer takes us seriously. Just remember, on election day, to get out and vote and vote often. This is true Democracy at work and it ain't over till it's over.

Jack

Florida and "Equal Protection clause?" Ha! Are they still leaving the methods of voting up to each voting district? And using good vote counting machines in the "nice" areas? What's the latest on K. Harris and the very extensive purge list of "felons" who have served their time ........... and those of similar names? Aaah, yes a vote recount stopped indeed! ...under a decision not to be "used as precedent".

neilehat

Jack, K.Harris huh? I heard she wanted to be a Senator, but the payoff didn't materialise after the act. I wonder why?

Chenglin liu

Dear Judge Posner,
I use your book Economic Analysis of Law (7th ed.) in my law&Econ class at St. Mary's University School of Law. It's a great book!
I have a question on Figure 7.1. regarding war on drugs. It seems that qs and qd should be ps and pd. I would appreciate it very much if you could send me an email at cliu@stmarytx.edu
Sincerely,
Chenglin Liu

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