Overcoming Bias

Election Gambling History

While it is sometimes claimed that political betting markets are a recent invention, they clearly are not.  Rather it is the absence of such markets during the mid- and late-20th century which is the exception.

Rhode and Strumpf illustrate their point:

Quotes of betting odds on papal succession appear as early as 1503 when such wagering was already considered "an old practice." ... Aversion to such activities eventually led Pope Gregory XIV, in March 1591 to ban on pain of excommunication all betting on the outcome of papal elections, the length of the papal reign, or the creation of cardinals. ...

Grateful For Bad News

Speculators were blamed for rising oil prices a few months back, but not for recent falling oil prices.  Short-selling speculators were recently blamed for falling stock prices, and actually banned for a few weeks, but no one proposed banning buying speculators two years ago when stocks were rising.  Now Steven Pearlstein of the Post wants to close financial markets for a week:

What we need to do is to stop making things worse by continuing to over-rely on financial markets and financial institutions that have proven to be incapable of performing their core missions: getting capital to where it needs to go and pricing that capital in a way that reflects the risks and underlying economic values. We have to stop digging. Another week like this one, and there won't be much left to rescue. 

To begin, the markets could use a timeout just about now, something that lasts longer than a weekend and gives policymakers around the world the chance to get a good nice sleep and evaluate their options without feeling like they have to respond to every movement flashing across their Bloomberg screens.  It would allow some time for passions to cool and for real investors to regain control of markets now dominated by the computerized short-term trading strategies of hedge funds and hot-shot money managers desperate to recoup some of their losses.

I can't imagine Pearlstein suggesting closing newspapers for a week, or banning them from printing bad finance news for a few weeks.  So Pearlstein doesn't get it:  financial markets are news institutions, just like newspapers!  The fact that newspapers report a lot less news on this crisis on weekends shows that most crisis news now comes via financial markets.  Don't blame the messenger for telling you bad news; blame those who caused the bad news, and who keep you from learning sooner.

Intrade and the Dow Drop

With today's snapback, the Dow lost 777 and regained 485.

As of this evening, Intrade says the probability of a bailout bill passing by Oct 31st is 85%.

(777-485)/(1-.85) = 1,946.  So a bailout bill makes an expected difference of 2000 points on the Dow.

Of course this is a bogus calculation, but it's an interesting one.  Not overwhelmingly on-topic for OB, but it involves prediction markets and I didn't see anyone else pointing it out.  I hope the bailout fails decisively, so this calculation can be tested.

White Swans Painted Black

Nassim Taleb has an article related to the current financial crisis. While much of what he says is true, he misleads when he implies that the recent collapse of financial companies resulted from a Black Swan. He claims:

use of probabilistic methods for the estimation of risks did just blow up the banking system

Cowen Disses Futarchy

From a recent Telegraph article:

Professor Tyler Cowen, also of George Mason University, thinks that the problem of bad governance is far too complex to be solved simply by making predictions of how policy decisions may or may not turn out. "I don't agree with the futarchy idea," he says. "The record of prediction markets is a strong one, but I wouldn't want to use them to run an entire government.

Imagine a similar statement on voting:

The problem of bad governance is far too complex to be solved simply by having citizens elect representatives.  The record of representatives is strong, but I wouldn't want to use them to run an entire government.

Or imagine similar statements about propositions, laws, judges, administrative agencies, public hearings, free press, constitutions, etc.  See the problem?  Every institutional mechanism is going go be far simpler than the complex problems to be solved - can that really be a reason to reject them all?

Intrade's Conditional Prediction Markets

We have often discussed the possible benefits of prediction markets for reducing bias. One key element that could be particularly useful is a conditional prediction market, where betting claims are based on outcomes conditional on some factor we want to evaluate. Robin recently mentioned the possible benefit from market claims on longevity or health conditional on various interventions.

Unfortunately, there are few prediction markets in the world, and fewer conditional ones, so it is hard to know how practical this institution may become. Thanks to an initiative by OB contributor Peter McCluskey, Intrade - the large, real-money prediction market - has added conditional claims based on the outcome of the U.S. Presidential elections. These may represent the first major case study of real-money conditional futures markets. So how are they doing? Here is some data and analysis.

Because of how the conditional claims are computed, we need to normalize the results by dividing the claim prices by the probability of a win for that party's candidate. At the moment I looked (2008-07-28, 5:00 PM PDT), clicking on Politics and "2008 US Election", and expanding "2008 Presidential Election Winner (Political Party)" I saw that the odds for a Democratic victory are 66.7-67.4. The claims are based on Democratic vs non-Democratic victories, so we will use the complementary odds of 32.6-33.3 for a non-Democratic win.

Then clicking on the left on "US Pres. Decisions" gives us the six conditional markets funded by Peter McCluskey.

Here are the claims, the prices, and the normalized values found by dividing by the corresponding Democratic and non-Democratic victory probabilities above. To compute the normalized values, I divided the lowest claim price by the highest party-victory price, and the highest claim price by the lowest party-victory price, giving the maximum range consistent with current trading prices. (Peter provides continually-updated information on current implied values as well.)

Claim	Dem price	non-Dem price	Dem norm	non-Dem norm
Increase in US government debt (over $10 billion)	51.2-53.7	34.4-36.5	76.0-80.5	105.5-109.6
Number of US troops in Iraq on 30 June 2010 (over 2000)	41.3-43.8	32.1-34.3	61.3-65.7	96.4-105.2

These prices imply that the market expects that under a non-Democratic administration, we will see substantially higher government debt, as well as much higher numbers of soldiers in Iraq.

Refuge Markets

The topic of global catastrophic risk seems silly to many, and my conference talk last Friday on refuges against human extinction seemed even sillier to some - Ron Bailey had fun comparing me to Dr. Stranglelove, and Spiegel saw a colorful character.  Silly or not, however, refuges seem a cheap way to save humanity from worst-case disasters. 

My talk went beyond my book chapter to reach a new height of silliness - I suggested refuge ticket markets.  Beyond my obvious need to be sillier-than-thou, I had another motive: to let prediction markets identify scenarios where catastrophe is a serious risk, and then advise us on how to avoid these scenarios. 

You see, speculative markets have an obvious problem forecasting the end of the world, as no one is left afterward to collect on bets.  So to let speculators advise us about world's end, we need them to trade an asset available now that remains valuable as close as possible to the end.  Refuge tickets fit that bill.

Cloud Seeding Markets

Nature considers cloud-seeding:

Chinese meteorologists will use weather-modification technologies to try to stop rain from spoiling the [Olympic] party. ... Official figures ... say that the country created 250 billion tonnes of rain between 1999 and 2006. ... Critics say that many of these claims are laughable, and that most of the projects under way are based on little more than faith. ... Today, countries from Australia to Iran practise some form of cloud-seeding - as do nearly a dozen US states. ...

Some Chinese rain-makers have tried to conduct controlled seeding experiments. ... In the early 1990s, the researchers found that rainfall rose by 18% as a result of 21 seeding operations - but the sample was too small for the results to be statistically significant.  In an earlier study, conducted between 1975 and 1986, meteorologists in ... southeast China, conducted a randomized seeding experiment with two 14,000-square-kilometre regions. Over the course of 244 experimental days, they found that areas that had been seeded had 20% more rainfall than did those that had been left to their own devices.

CFTC Event Market Comment

In May the US CFTC declared that it was considering offering more legal approval for "markets commonly referred to as event, prediction, or information markets."  They requested comments, due by today.  My comment concludes:

In addition to existing regulatory regimes for ownership-hedging securities, idiosyncratic-risk-hedging insurance, and common-risk-hedging futures, it could make sense to have a distinct regulatory regime for markets whose main reason to exist is the info that they collect.  Compared with existing commodities futures regulation, such a regime should set a much lower barrier to creating such markets, as much of the social value may be distributed in millions of small markets.  And while it is hard to determine in general which markets would create high social info value, relative to cost, we should presume such high value when a sponsor is willing to pay to ensure that traders suffer no average financial cost from their participation.

Added:  I'm off in a few hours for a two week trip to Helsinki and then Oxford.  I have posts ready for while I'm gone, but I expect to comment less often. 

Prediction Market Based Electoral Map Forecast

Slashdot points to ElectoralMap.net, a site which aggregates the Intrade prediction market results for individual states in the fall U.S. Presidential election, to predict aggregate electoral college totals and the election winner. I'm bookmarking it as an alternative to media coverage of the race, which will put their own spin on likely outcomes. Note the arrows at the bottom of the map will allow you to track the changes in sentiment over the weeks and months leading up to the election.