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A Few Words on Prediction Markets

Posted By Barry Ritholtz On May 26, 2005 @ 11:36 pm In Markets | Comments Disabled

A recent conversation with a friend made me made realize how easy it is to be misinterpreted, especially on more complex issues.

Let me clarify my views on the so-called prediction markets [1].

In the past, I have very strongly dissed [2] some people’s concept of these markets and their ability to “predict” the future. The primary reason for my view is the unfortunate tendency for some people to place way to much faith in the crowd to know the unknowable [3].

I have yet to see a reasonable explanation as to why IEM missed Dean’s collapse [4] in the primaries; a commentor notes that the American Idol contract on Tradesports had Bice 90% favored [5] in the final minutes — but lost.

That said, I rely on many forms of market action to provide color to my expectations. Trend Following is one obvious area. The Fed futures are another. All of technical analysis requires interpreting price and volume changes. I would be lying if I said I didn’t think the Bond market was saying something.

So when I dis prediction markets — especially about their lack of liquidity and small trading pool — its a slight. It reflects my general disdain [6] for the efficient market hypothesis [7], amongst other flawed theoretical concepts. When it comes to explaining market behavior, I’m more of a Chaos-theory [8] man myself.

The difference between the Bond market and say, the Iowa Electronic Markets [9], NewsFutures [10] and the Hollywood Stock Exchange [11] or Trade Sports [12] is in the size, scale, and liquidity. I am agnostic about these smaller markets, but I do not discount the possibility that any mechanism can potentially provide some insight into future market behaviors.

On a related note, I am reading (quite skeptically) the Wisdom of Crowds [13] — something quite related to the concept of prediction markets. Its a book that I find slow going because of the continual fisking it requires. While its a pleasure to read Surowiecki [14]‘s prose, on most of the market related items I’ve gone through there are readily identified logical flaws and unsupported assumptions. (More on this in the future).

As to the Prediction markets value, I remain an interested skeptic.
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If you want  to learn more about Prediction Markets, than the meta page you want to see is Chris Masse’s prediction market vortal [15]. There’s a ton of data and links there to get you started . . .

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URL to article: http://www.ritholtz.com/blog/2005/05/a-few-words-on-prediction-markets/

URLs in this post:

[1] prediction markets: http://en.wikipedia.org/wiki/Prediction_market

[2] dissed: http://bigpicture.typepad.com/comments/2004/10/presidential_fu.html

[3] crowd to know the unknowable: http://bigpicture.typepad.com/comments/2005/02/political_futur.html

[4] Dean’s collapse: http://bigpicture.typepad.com/comments/2004/01/iowa_and_predec.html

[5] Tradesports had Bice 90% favored: http://www.tradesports.com/jsp/intrade/contractSearch/searchPageBuilder.jsp?z=1117168465403&expired=true

[6] disdain: http://bigpicture.typepad.com/comments/2005/03/the_hardly_effi.html

[7] efficient market hypothesis: http://bigpicture.typepad.com/comments/2004/11/the_mostlykinda.html

[8] Chaos-theory: http://www.amazon.com/exec/obidos/ASIN/0140092501/thebigpictu09-20

[9] Iowa Electronic Markets: http://en.wikipedia.org/w/index.php?title=Iowa_Electronic_Market&action=edit

[10] NewsFutures: http://en.wikipedia.org/w/index.php?title=NewsFutures&action=edit

[11] Hollywood Stock Exchange: http://en.wikipedia.org/wiki/Hollywood_Stock_Exchange

[12] Trade Sports: http://www.tradesports.com/

[13] Wisdom of Crowds: http://www.amazon.com/exec/obidos/ASIN/0385503865/thebigpictu09-20

[14] Surowiecki: http://www.amazon.com/exec/obidos/search-handle-url/index=books&field-author=Surowiecki%2C%20James/102-1793806-1323309

[15] prediction market vortal: http://www.chrisfmasse.com/

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