Knaddison.com - prediction markets

Hillary Clinton - The Market Predicts She's Done

greggles — Sat, 24 May 2008 20:55:50 +0000

As we flew home from our trip to South America we changed planes in Washington DC and saw this scene:

I’d say that this is a pretty clear indication that, at least in the opinion of this airport shop owner, Hillary Clinton’s chances of becoming president are pretty low. That’s what you might describe as a general market indicator that Hillary is done.

And, of course there’s the prediction markets…

Prediction Markets - HubDub Says Hillary Clinton to Withdraw Before the Convention

According to the HubDub market there is an 82% chance she’ll withdraw prior to the convention.

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what is this?

Will Hillary Clinton withdraw from the nomination race before the Democratic Convention?

% chance over time

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Hubdub - The News Prediction Game

At least this prediction, at the time I’m writing this, says there’s about an 80% chance that Hillary will leave prior to the convention.

If you’re on HubDub, you can become my “friend” and then we can compete in predictions. When starting at my HubDub profile you should be able to click a button at “add as friend”.

Switchy McSwitchenstein - Playing with Markets

greggles — Sat, 01 Mar 2008 14:31:50 +0000

Yeah, the thing about a prediction market people can mess with is that people can mess with it.

Reports and Alerts for Prediction Markets

greggles — Tue, 20 Nov 2007 14:53:10 +0000

So, what information do you want to see in prediction markets?

Reports and Alerts for Prediction Markets

Certainly graphs that show the price history and volume with Open/High/Low/Close is mandatory. It would be nice if these graphs could be both snapshots and updating (i.e. provide links that show a period in time and links that show most recent).

For an individual they (and admins) will want to know Open Orders and Order History on a per user or a per security basis (or per user per security, perhaps).

Another graph I’ve heard of is the “Shape of the Book” that would show a list of all open orders with their volume on bid and ask sides. This would let a trader know how far they would need to go in price to fulfill an order of a certain size. Interestingly enough InTrade provides a small amount of this information (the first 20 records or so) while some of the others you have to sign up to get to a point where you could see so I don’t know…

Some other interesting informtion is some “arbitrager’s helper” functions such as “If this set of contracts is worth what it trades at, what does that imply about other prices in the market”. For example, in a Democratic Nomination for 2008 $1 contract if Hillary trades at 40 cents, Obama and Edwards trade at 20 cents, and the Field trades at 25 cents then there is a market inefficiency because one of the items is trading too high. In this case a trader would be best off, for example, buying an entire book and selling the pieces individually (though it probably indicates an illiquid market where that action wouldn’t be possible).

Alerting Systems

There are probably a few channels of alerts that should be created as well. Delivery mechanisms would ideally be up to user preference between RSS, Email, SMS on a per channel basis.

Trade alerts (executed, marked invalid, etc.)
Price alerts (above/below a limit)
New offer alerts
General system alerts (introduction of new features, policies, maintenance)

Any other reports or alerts that traders are going to want?

Prediction Markets - Issuing Contracts via Unit Portfolios vs. Buy/Sell

greggles — Tue, 30 Oct 2007 00:57:35 +0000

The first order of business in any options exchange is getting options onto the market.

Issuing new Contracts

Tradesports achieves this (as far as I can tell) by allowing every member of the exchange to either buy or sell any option. Everything is done on margin until the option expires. If you “buy” a position, (i.e. there is an offer order at or below your bid) the price at which your order was bid multiplied by the number of contracts you purchased is placed into a holding status in your account. If you “sell” a position then the sale price minus the expiration value is also put into holding status in your account. When the contracts expire - “buy” accounts are given a dollar if the event occurred - “sell” holders are given a dollar if the event didn’t. Frankly, that makes my head hurt

IEM has a simple process for issuing contracts: unit portfolios. If your contracts are about whether a coin toss will produce a 1) heads or 2) tails or 3) land on its side then they issue a new “unit portfolio” by selling all three of those for the expiration price. Since they represent all possible outcomes, the total value is defined as the expiration price (generally $1). Then it is up to the trader who buys the portfolio to determine what price they want to sell an individual option. If you want to “short” a particular option, you simply 1) buy all of the rest of the contracts that comprise that unit portfolio or 2) buy the unit portfolio from the exchange and sell the one contract that you wanted to short.

In practice these systems are amazingly similar. The question then becomes - which is simpler to explain, understand, and count?

New Options within a Series

One question I have is how each handles a new outcome that becomes possible within a series. Looking at the IEM again, initial contract portfolios include a bundle that represents all possible outcomes. The 2008 Democractic Nominee Market opened with 4 possible contracts: Clinton, Edwards, Obama, and “Rest of Field.” What happens if a new candidate not in the initial list becomes the most likely winner? In that case the “Rest of Field” contract comes to basically represent that candidate. The IEM provides the possibility of a “spin off”. They declare a point in time to spin off that candidate from the Rest Of Field contract - all holders of a “Rest of Field” contract at that time would receive one additional contract for the new candidate. They could then trade that contract as they saw fit and from that point forward any unit portfolios purchased would include this new option.

TradeSports uses a system where they begin a new series and accept suggestions within that series for some amount of time. They will then stop accepting suggestions and add a “Rest of Field” contract. Given the ability of an individual to make a late dash for a race that seems like it could be limiting.

Comparison of Predictive Electronic Options Trading Markets

greggles — Sun, 28 Oct 2007 13:45:27 +0000

I’m doing some research into how electronic options markets work - and specifically those used primarily for prediction purposes. I’m familiar with them (previously wrote about prediction markets and political contracts).

The two big exchanges that I’m looking at are the Iowa Electronic Market (IEM) and TradeSports.com. Both are “real money” markets. The IEM is focused on political events and on using the market as a “petri dish” that the associated business school can analyze to learn how markets work. TradeSports.com is strictly a business focused on making money by acting as a broker. They take fees for various events - trading and withdrawing money. TradeSports.com also provides their data to educational institutions, probably for marketing reasons, and have been reviewed and cited by the respected finance professor Jeremy Siegel.

I plan on writing more on Prediction Markets over the next months and here is a bit of a roadmap for things I know I want to talk about. You can find new articles by going to prediction markets page or by using the prediction markets rss feed.

Reason for Markets

The basic motivation for these markets is twofold: for the individual traders to make money and for the spectators to get high quality predictions about complex events. Both of these are easier said than understood. So, I’d like to gather resources and citations that make it clear how the fundamentals of trading work and why these markets are successful at predicting events.

Major Events in Markets

The major events in any options market are basically the same:

Initial Issues of Contracts - similar to an Initial Public Offering or IPO
Trades of Contracts the bread and butter day to day activity
Contract Expiration - where fortunes are made

Each one is relatively simple in theory - issuing contracts is when they first become available for trading, simple enough - but the reality of how these are structured and function can be complex - for example, the IEM uses contract bundles to create a market which is different from Tradesports margin based system. The possible ways to place a trade are myriad and complex as well - market order, “fill or kill”, “stop/loss” - what do they mean and how do their differences impact a market?

Problems with Markets

Aside from the most obvious problem - the complexity of markets for every day users - what other structural problems can markets face? How can different decisions in constructing markets lead to more - or less - efficient marketplaces. And of course what technical and housekeeping decisions need to be made to ensure smooth functioning of the markets.

Predictive Markets - Can't Wait Until 2008

greggles — Tue, 21 Feb 2006 02:59:11 +0000

Predictive Markets

Predictive Markets are a really neat idea. Basically, you let knowledgable people bet on the likelihood of a particular event happening: Bush getting re-elected, 10 inches of snow falling in one day on New York City by 2008, or Nikki letting me buy a new computer this year. Then the price of the contract for that particular event will then reflect the collective knowledge of the community about that event. If you have something that is hard to analzye or hard to predict, this is a great way to get a fairly reliable answer.

Greed is good

The quality of the prediction is the basic concept behind Efficient Market Theory. Efficient Market Theory says that when information costs and trading costs are low enough, markets will seize upon any inaccuracies in the price of a security and will then price that security at a price that the market judges collectively to be an accurate price. The Gordon Gekko version of it is “Greed is good” because it makes sure that market prices accurately reflect the knowledge about that security. Is oil relatively cheap? Efficient Market Theory says that’s because it’s more plentiful than the anti-oil activists would have you think. Is it getting more expensive? Perhaps it is getting less plentiful or otherwise difficult to deliver.

The use of efficient markets as an indicator is extremely useful. The “invisble hand” is also based partially on the idea that vendors will see prices rising on a certain good—following in my example, oil—and then use that rise in prices to decide to make a larger investment in exploration, refineries, or alternative technologies. Similarly, markets that are created solely for predictive purposes such the “George Bush Re-Election” contract I mentioned above are extremely useful themselves.

How reliable is this?

Well, in 2004 the various gambling and predictive market sites had Bush re-election running at a slightly positive likelihood of happening for basically the entire year before the election. Only on election day did the initial exit polls (which were wrong, again) swing the prediction markets into a Kerry win for a little while before the evening came and they swung back to Bush.

In a fairly different use, the Google Blog discussed internal use of prediction markets as it relates to product release dates and other difficult to predict issues.

How does this impact my life?

Well, let’s say that you are one of the many people who is interested in the 2008 elections. The following are tradesports contracts for some relevant events. They are $1 contracts, so note the scale on the left hand side of the graph. The closer to 1 that the graph is, the more likely the market thinks the event is to happen.

John McCain winning Republican Nomination for President in 2008

Well, that’s the most likely event out of the group of candidates for that nomination according to tradesports.

Hillary Clinton winning Democrat Nomination for President in 2008

Republican Candidate to Win in 2008

Democrat Candidate to Win in 2008

Field Candidate to Win in 2008

And…

Well, for the McCain supporters of the world, it looks like 2008 will be a good year. If you like Hillary, she is probably going to get the nomination but is not as likely to be president. Interesting stuff folks, interesting stuff.