Prediction Markets: When Do They Work?

https://thezvi.wordpress.com/2018/07/26/prediction-markets-when-do-they-work/

by lainon • 8 years ago

230 58 8 years ago

thezvi.wordpress.com

wpietri2• 8 years ago

This is basically unreadable without the previous article in the series. It's linked at the top, but this is it: https://thezvi.wordpress.com/2018/07/26/prediction-markets-w...

dang• 8 years ago

In that case maybe we'd better switch the URL to that and leave the second one here: https://thezvi.wordpress.com/2018/08/17/subsidizing-predicti... (originally posted as https://www.lesswrong.com/posts/AeKS2m6uLM8RYfvND/subsidizin...). Thanks!

paulpauper2• 8 years ago

sports betting and commodities futures could be considered types 'prediction markets' that seem to work pretty well. The reason why prediction markets have not caught on is due to regulation and that most markets are tiny and prone to manipulation and low liquidity.I also think that insurance acts as a counter-party instead of having to use a market.

seibelj• 8 years ago

Eventually an anonymous prediction market will take off, and that will be the end of insider trading enforcement. People in the know will bet on the stock price via the prediction market, and the market will react based on those bets.

chatmasta• 8 years ago

Or the stock market will adjust to the predictions and any advantage will be lost.

rossdavidh• 8 years ago

In theory, once that happens, anyone who does not have insider trading knowledge will leave the market, either because they keep losing and don't like that, or because they run out of money to lose.

paulpauper2• 8 years ago

insider trading is not proof of material information though, and inside trades as per SEC are disclosed to public. it only becomes illegal when it's done knowingly in anticipation of disclosure materially significant news, but even if one could see the trades being done, one would have no way of knowing why unless they were insiders themselves. Just blinding following insider trades will likely lead to many false signals.

lordnacho2• 8 years ago

https://en.wikipedia.org/wiki/The_Market_for_Lemons essential paper for thinking about this.

gruez• 8 years ago

options/futures are essentially prediction markets, and they already exist.

currymj• 8 years ago

but not anonymous — they are definitely monitored, not really useful for insiders to do insider trading. after all, Matt Levine’s second rule of insider trading is “don’t do it by buying short-dated out-of-the-money call options on merger targets”.

dooglius• 8 years ago

How would this differ from people now communicating with insiders anonymously, say via Tor?

baddox• 8 years ago

The main difference I see is that you wouldn’t trust an anonymous tip by a supposed insider, but you would trust transactions in a well-reputed anonymous prediction market.

nabla92• 8 years ago

If you make substantial sum of money and try to use it in the real world, they have to show it's origin or it's confiscated. In most of the world anything larger than $10,000 or 10,000 EUR is tracked.

We have anonymous money for the most of the history and laundering the money into legitimate money has always been difficult and expensive process. It can be done but you pay typically 20-30% for the service and it's risky.

baq• 8 years ago

The article clearly says what will happen: there won't be enough participants that would be willing to be suckers in that market, hence it'll die quicky.

gpm2• 8 years ago

You could make guaranteed money on it as a "sucker", just run an arbitrage between it and the stock market.

arisAlexis4• 8 years ago

an article cannot clearly predict what will happen. It can assume. Don't take it as Bible and keep an open mind into the future.

wpietri2• 8 years ago

Ok, having finished both articles, a few thoughts from somebody who has been involved for years in the subsidized prediction service Long Bets: http://longbets.org/

Broadly, I think he's right. Subsidized prediction contexts could provide real social benefit. It can force a lot of attention and thought around topics that don't get enough consideration. I would love to see, for example, a bunch of VCs covering the costs on a prediction market for the tech sector. Have a bunch of standard running questions, and let the VCs ask any question they want.

I think he is 100% correct that having well-defined bets is hugely important. We got our initial bets by careful, personal assistance to get people with contradictory opinions to agree on clear, testable criteria. We thought once we got going people would just do that on their own, and we were wrong. Sometimes it happens, but pretty rarely.

I wonder about the extent to which his emphasis on speed is about a particular kind of participant (e.g., sports gamblers and day traders). Most of the people I know who invest work at the months-to-years timescale, so I suspect there's an untapped cognitive surplus from people like that which could be applied to longer-term questions.

I also think his notion of subsidizing market makers (who are obliged to provide liquidity) is a good one. I used to work for a market-maker and it was not a bad business to be in. His no-fees market makes that trickier, but I don't think it's unresolvable.

One subsidy option that I'm surprised is not here: guarantee a minimum purse for people on the winning side of a question. Somebody is going to show up to try to get the free money. And then somebody smarter is going to say, "I'd bet I can get a piece of that." I know it wouldn't take much for me to place some bets on some current hot issues. E.g., blockchains, Bitcoin, Uber, scooters, VR, AR.

skybrian2• 8 years ago

I think it might be less an emphasis on speed and more about whether you are interested in making money (or at least the logic of making money), and therefore compare bets with alternative investments. Serious gamblers are at least going to compare with alternative bets, and being able to place more bets over a year with the same bankroll is an advantage if you have an edge.

More broadly, if you squint a bit, the stock market looks like a betting market that's subsidized by company profits. It would take quite a bit of subsidy to compete with that.

I suppose cryptocoin shows that people will bet in unsubsidized markets, if part of the bet is whether they will later be subsidized and to what level.

Edit: it seems the URL changed and we are responding to different articles.

thaumasiotes• 8 years ago

Serious gamblers are at least going to compare with alternative bets, and being able to place more bets over a year with the same bankroll is an advantage if you have an edge.

This is only true under one of two assumptions:

1. Your edge on the long bet is numerically similar to your edge on the short bet, such that making more bets means getting more money overall.

2. You're looking to stabilize your earnings by placing a large number of bets, even at the cost of lower expected gain.

There's no reason winning more bets automatically means more money. The longer bet might have longer odds.

nabla92• 8 years ago

For political, other major events or sports betting, normal brokers are more efficient. They have spread something like 5% or less. Financial markets can be even more efficient. Existing betting markets typically take something like 10% for the same bet. There is little reason to go to them unless there are some rare arbitration opportunities.

I think these new prediction markets should differentiate from traditional betting markets in some meaningful way.

One possible idea: marketing the skill. Turn prediction market into expert market. People would invest money to experts (individuals, syndicates even algorithmic syndicates).

Rough idea: trading is anonymous until the underlying is settled. Then the market participants get a cumulative score they can use to sell their experience and get investors. The system would show the expected value form investors, quantified risk and uncertainty. Individual investors and investor syndicates can start with very little cash and demonstrate their skill. Complete nobodies could become renowned experts over time and sell their expertise.

This would could be very good way to provide value in emerging markets. Some Kenyan or Vietnamese market or political analyst could emerge from nothing over few years and sell their expertise to bigger players without PowerPoints, marketing skills and connections.

arisAlexis4• 8 years ago

there is no book spread in Augur though that's the point. Pure p2p gambling

lordnacho2• 8 years ago

Sounds a bit like a change of numeraire he's talking about there wrt things being prices in Ethereum. https://www.math.nyu.edu/~alberts/spring07/Lecture3.pdf

conjecTech2• 8 years ago

Ugh. I'm torn when I see things like this. I sincerely like the rationalist community, but I never quite engaged with it. And posts like this seem to confirm that it was probably a good decision on my part.

The author identifies 3 successful instances of what he wants to exist, and then fails to ask the question of "how do they accomplish what I want to?"

In particular, one of the marketplaces, the financial markets, is several orders of magnitude larger than the others and has a huge vested interest in getting issues like this right. And they largely have.

For instance the capital issues are handled through a broker system, where the aggregation of opposing bets allows for mitigation of risk from margined bets, and the settlement processes, such as daily settlement of price differences in futures.

If you're trying to build something complex, it's probably a bad idea to start from a blank slate. A lot of our existing solutions were hard-won, and it would be a shame to simply discard that understanding. The programming community, and others connected to it, seem to disregard history and existing institutions as obsolete or to be distrusted. For a field that's less than a century old, that's somewhat defensible. Nassim Taleb makes the point in Antifragile that ideas usually have something akin to a constant hazard rate. Something old which is still used is less likely to be replaced than something that has only been around for a short while. The nascency of most of science makes it hard then to determine what is and isn't fungible. But marketplaces are as old as trade. The aspects that we see in them are far less arbitrary than you'd think, even if it's hard to express exactly why they are there. If you're going to work at building another version of something that has been around for so long, you'd be wise to start by analyzing and understanding what is already out there. I think it's the engineering equivalent of Eric Weinstein's policy around talking to people you know to be intelligent. If they seem to be saying something obvious, they are probably saying something subtle. And if they say something that seems wrong, they may instead be saying something counterintuitive. Similarly, if part of an antiquated system that is still in use seems to be useless, needlessly complex, or downright harmful, there is a good chance that you simply don't understand it.

I was really excited last year when I saw some people within lesswrong trying to become more accommodative and appreciative of "hufflepuffs" within the community (https://www.lesswrong.com/posts/DbdP8hD2AcKcdSsgF/project-hu...). I really hope that effort continues and sees fruition. Hangups like this could be easily spotted and remedied by having a contingent of people who are less philosophical and more battle-hardened within your ranks.

browsercoin• 8 years ago

yeah I had a very strong skeptical attitude while reading the article. For me, it raises some flags when it's alleged the author is in the business of selling prediction markets, you are gonna read only the good parts.

I find it hard to believe that a prediction market will be able to outperform hedge funds. It's an open secret that insider trading is rampant despite SEC enforcement, so unless those hedge funds are participating in these prediction markets, it's hard to put any value especially at this early stage.

I can definitely see a use for internal opinions, like, do we need a new CEO? and then putting the equilibrium forces of an efficient market to work. Best Buy tried it and I'm not sure if it's still being used decade later.

Sniffnoy• 8 years ago

Zvi Mowshowitz is in the business of selling prediction markets? Are you sure you're not confusing him with Robin Hanson?

adam2• 8 years ago

Actually, prediction markets need some sort of objective, verifiable outcome, so asking "do we need a new CEO" wouldn't be appropriate. Instead the company could ask questions related to the performance metrics the CEO has agreed to meet. "Will we meet sales levels of X?" "Will we achieve x% market share in Y product by Z date?" etc.

And based on the probabilities output by the market, if they were low and trending lower, one could argue there is at least a perception that this CEO isn't getting it done. Or another response could be "why" which could encourage a more open, healthy dialogue internally.

antidesitter• 8 years ago

An analogy is rewriting a codebase from scratch to retain only what is really necessary and experiment with large-scale architectural changes.

trishume2• 8 years ago

I happen to have met the author in person and know that he's very familiar with financial market details.

When reading the article I didn't get the impression he was trying to say we should abandon or ignore the way financial markets work at all, I got the impression he was trying to document the essential reasons why existing financial markets work so well as they could be applied to prediction markets.

conjecTech2• 8 years ago

He listed a necessary attribute/problem to be overcome without mentioning the solution that already exists in one of the most prominent markets that exist. I understand what he was trying to do, but that seems pretty revealing.

And again, it wasn't his particular knowledge I was criticizing. It was the way, from my understanding, he applied it towards solving the problem of creating the incarnation of prediction market that he wants. Asking why you couldn't just convince CBOE to introduce these kinds of things would probably be far more revealing than trying to piece together all of the necessary conditions for a prediction market from recollection and anecdote.

mlthoughts2018• 8 years ago

Always worth a read in these discussions. Hanson has a prediction market business, Consensus Point, so there’s at least two sides to the issue: convincing specific customers to care vs the general applicability.

https://www.cato-unbound.org/2011/07/13/robin-hanson/who-car...

Hanson is not naive about the social and political barriers. This goes far beyond prediction markets, extending to all kinds of uses of forecasting and statistics in industry where political gatekeepers want to control the implications of models, rather than caring about objective truth first and mollifying it towards business concerns second.

Agnosco• 8 years ago

For anyone interested in this field should take a look at the work of Ulrik William Nash. I had the pleasure of completing a course led by Ulrik as well as writing an internal paper with him as my supervisor:

His main paper on wisdom of crowds and skew, which is rigorous (free): https://journals.plos.org/plosone/article?id=10.1371/journal...

Short presentation: https://www.youtube.com/watch?v=yqTbzSHi-UQ

The paper above is worth reading for anyone interested in the utilization of collective wisdom.

Havoc• 8 years ago

I seem to recall at least one instance where the prediction markets absolutely killed it on the US state elections, so yeah I'd say yes.

Bucephalus355• 8 years ago

Prediction Markets were at one time supposed to be the “secret weapon” of neoliberalism. They would so predict the future, that corporations would become unstoppable, much like the company that hires Ben Affleck in the movie “Paycheck”.

Most laughably, in 2003, Admiral John Poindexter, thought it would be a brilliant idea to launch a “terrorism and coups-d’etat prediction market”.

About 2 months after it launched, he became persona non grata in the Washington defense scene and was forcibly retired from DARPA.

http://www.cnn.com/2003/ALLPOLITICS/07/29/terror.market/

https://en.wikipedia.org/wiki/Policy_Analysis_Market#Proposa...

arisAlexis4• 8 years ago

well decentralisation so oves this problem exactly

nonbel• 8 years ago

I would bet there is almost no overlap between the people betting in prediction markets and those who dont screen email/websites/calls (ie, answer polls honestly).

kolbe• 8 years ago

The biggest market there, by far, is on whether Ether will trade above $500 at the end of the year. This is an interesting market because Augur bets are made in Ether. So even though the market (as of last time I checked) says it’s 74% percent to be trading above $500 and it’s currently $480 (it’s currently Thursday, July 26, and I’m not going to go back and keep updating these numbers). When I first saw this the market was at 63%, which seemed to me like a complete steal. Now it’s at 74%, which seems more reasonable

Hi. My job is to essentially figure out reasonable probability distributions for securities on which to price derivatives contracts. Certainly, due to some securities having negative skewedness, it's common for a stock to have more than a 50% chance of going up. I've seen it as high as 65%, but the counterpoint to that is that there's usually very small probability that it goes a lot higher.

I would love to know what probability distribution this guy is using to think that the probability of going up over $20 being 74% is reasonable.

dmurray4• 8 years ago

As I read it, it says a 74% chance of going up if you look at the market naively and forget that it's priced in ETH. Since it's priced in ETH, you can't derive the probability that ETH goes up directly - there are an infinite number of sets of probability distributions that are consistent with any price. If it goes up, you get paid off more (in USD), so if you thought the odds were 50% of it going up and you were offered an even money ETH bet, you should jump at it.

40four• 8 years ago

Seemed like an interesting article until halfway through the 1st paragraph, (on mobile) a full screen ad locked down my whole screen and caused me to close the broawer tab. Booo

blazespin• 8 years ago

Weak. Any proper treatise on this would be mathematical. A comparison of polls versus prediction markets would be appropriate, based on intervals of confidence.

ryeguy_24• 8 years ago

I’m new to this concept. Can someone help explain how prediction markets are used for good? Given that this is a zero sum game, isn’t this just facilitating the transfer of money between the winner and the loser.

adam2• 8 years ago

In the public context, people often cite the consensus predictions to get a better understanding of what people _think_ will happen vs. what they _want_ to happen.

In a corporate context, prediction markets are often used internally amongst employees to predict things like sales forecasts, ability to hit milestones, budgets, quantify risks, and predict the outcome of strategic initiatives.

In both contexts, people tend to participate anonymously so they have the freedom to express what they actually think. Contrast this, especially inside a company, with the politics of saying what you actually think. That "reality based" discourse is unheard of, especially in larger organizations. Prediction markets are often the only venue someone can express themselves in a productive way.

savanaly• 8 years ago

I think it's that everyone can see the odds of something happened that are indicated by the bettors in the market, and that's valuable information that can be considered the absolute best prediction that can be made based on available evidence.

I was watching the betting markets on the night of the 2016 presidential election. As I seem to recall, at the start of the night when people were still basically confident Hillary would win, I was watching electionbettingodds.com and it showed a ~30% chance of a Trump win, so I wasn't so sure. And of course it moved smoothly to nearly 100% as more information emerged and was incorporated into the markets. A good example of how betting markets are obviously not omniscient (or else they would have had 100% for trump), but a lot better than listening to your friends or even the top pundits.

dmurray4• 8 years ago

The article shows an excellent understanding of gambling and financial markets, but it's let down by the author's surprise about the terms of the "ETH over 500" bet.

This is a variation of a quanto future, which is well known and well understood in derivative pricing circles (see Wikipedia link). If you can price ETH/USD options, you can price this. Possibly it should be called a binary quanto.

https://en.wikipedia.org/wiki/Quanto

blacksqr• 8 years ago

If prediction markets are of any value, couldn't you set one up to answer this question?

qwtel• 8 years ago

I used to be excited about prediction markets for a while, but I've since accepted that, except for some niche applications, they won't be terribly useful and possibly even dangerous.

I was ultimately convinced by NNT's arguments, that a) prediction is the wrong thing to focus on (robustness or "anti-fragility" to wrong predictions is) and b) humans aren't good at predicting [the outcomes of complex systems] one way or another. PMs may be better than expert panels, but reality doesn't award extra points for being marginally less wrong.

Prediction markets are also called "information aggregation markets" and in that capacity they may be useful. Assuming all relevant information is out there, but doesn't properly propagate upwards a hierarchy for "behavioural" reasons (e.g. nobody wanting to be the face of bad news), then an anonymous (!) market could be the way for information in the low ranks to move where it is needed. In this case, there is hardly any "prediction" involved, and I assume it could work for that reason.

arisAlexis4• 8 years ago

I hooe you welcome some critique:

Remember, if you can’t spot the sucker in your first half hour at the table, then you are the sucker.

given there is no insider information in this case, this holds true to the stock market too.

There’s a lot of interest in what the odds are, but the volumes traded are quite thin, so much so that it is in the interest of partisans to trade in order to move the price and thus change the political narrative.

true when these markets are only a couple of bookmakers. Also true when there is a goobalized easy access anonymous system without a bookmaker's fee? Not so sure.

nostrademons2• 8 years ago

"Insider trading of securities is illegal....The problem is that it drives people away.

This is an interesting observation in light of some conversations I've had with 20-somethings who have abandoned the stock market in favor of cryptocurrencies.

For a couple decades now, the message has been "you can't beat the stock market. You're competing against top mathematicians who do this for a living and colocate boxes in the exchange so they can execute trades faster than you. Why even try when you're just going to be the sucker for some finance professional? Go invest in index funds instead." (Note that this advice is quite self-serving for a fund manager: it justifies the huge fees they charge. It's also quite self-serving for index funds, which compete on price.)

It seems like the youngest generation - the ones just leaving college now - took this to heart and figured "Well, if there's no point for us even trying in the stock market, let's just throw the whole thing away and invent a new asset class", cheerfully ignoring that they are also throwing out all the regulatory protections that protect against insider trading.

Even with all the SEC's insider trading laws, the existence of vast computer systems capable of crunching terabytes of data and executing a trade in microseconds now creates such an information imbalance that people are leaving the market anyway.

It makes me wonder if all markets have a natural death. As they get more efficient, liquidity dries up. Fewer and fewer people bother playing when they know that someone else is just going to get rich off them. Eventually the winner becomes like the kid on the playground who insists on winning every game; all the other kids refuse to play with him, and he's left shooting hoops perfectly alone. Meanwhile they go off and create a new game that is fresh enough that new entrants might actually have a chance - at least until somebody becomes really good at that, and the cycle repeats itself.

dillondoyle• 8 years ago

Yeah but stock market isn't zero sum... I can't tell if you're actually arguing don't invest in stock market because some HFT might get higher returns or some index fund will get .05% (somehow forgetting your 7% or even higher recently annual gains). Or perhaps you're trying to illustrate someone else's (wrong) mindset.

bluecalm• 8 years ago

I think you are over-estimating thinking process of people who buy crypto-currencies. I think vast majority buy them because of greed and ignorance about technology (they believe it's really the next big thing because that's what this or that popular blogger or video maker said). It's like buying a lottery ticket but it's easier to believe the chance to get rich is bigger.

>It makes me wonder if all markets have a natural death. As they get more efficient, liquidity dries up

100% efficient markets is dream come true for individual investor. Stocks represent equity in something that produces value. You want to put your money there at some point in your life and you want to sell that for cash at a different point in your life. There will always be people in accumulation phase and there will always be people in cash-out phase. The more efficient market gets the less likely you are to make a bad decision. Market efficiency cause by very good fast traders is fantastic for individual investors.

Imagine you hold for example AMD stock before recent earnings. You want to sell because you need cash. If the market weren't fast to react you (unaware of the results) might have sold for much less than the stock was worth. Those fast reacting traders just saved you whole bunch of money and you got a better price.

Sure, it's more difficult to buy something dirty cheap but remember that only happens if the other side is uninformed. The more efficient the market the less losses caused by information asymmetry and the more time saved which would otherwise be needed for research.

That being said I think the markets are far away from being efficient today.

imh• 8 years ago

It seems to have a natural equilibrium. The issue is that it's too popular and valuable, there are people putting too much effort in, so a casual investor won't get into it. If it were less popular and valuable, it wouldn't be worth putting so much effort in, so people wouln't, making it more appealing to a casual investor. The feedback loop seems to be stable.

randomracer• 8 years ago

What about a market that brings together buyers and sellers to bet on how companies are doing? A share price is really a function of how we expect a company to do in the future, but what if we bet on specific metrics? For example, I expect Company A to hit $100 in gross revenue this quarter, so I'd like to bet on it - as opposed to the several variables that affect share prices. The share price may reflect the Company's guidance - but revenues it expects in the future, but not really a reflection of history. This could also be a bet on other metrics - Snapchat number of users, etc. etc. I'd argue that this can be a more rational betting market. There are several metrics that aren't 100% correlated with stock prices.

Prediction Markets: When Do They Work?

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