Prediction Markets
Buying and selling a certificate worth a given amount of money if the prediction comes true, but worthless if it doesn't
Putting your
money where
your mouth is!
Buying and selling a certificate worth a given amount of money if the prediction comes true, but worthless if it doesn't
Putting your
money where
your mouth is!
People make
predictions
all the time
predictions
all the time
. . . e.g. about
other peoples'
reactions
other peoples'
reactions
. . . . . . ability to predict
the effect of
your actions on others
is useful
the effect of
your actions on others
is useful
. . . . . . you need a
"theory of mind"
"theory of mind"
. . . . . . you're in a
game theory
scenario
game theory
scenario
. . . . . . data suggests
competition within groups
may be a major cause of
human brain size
competition within groups
may be a major cause of
human brain size
Human brain. Credits: Patrick J. Lynch, medical illustrator; C. Carl Jaffe, MD, cardiologist. Http://creativecommons.org/licenses/by/2.5/
Chimpanzee brain. Credits: Gaetan Lee; tilt corrected by Kaldari. Http://creativecommons.org/licenses/by/2.0/
. . . . . . this is the
social competition theory
of human brain genesis
(ref.: Bailey & Geary,
Hominid Brain Evolution:
Testing Climatic,
Ecological, and Social Competition
Models
Human Nature,
vol. 20, no. 1,
Mar. 2009, pp. 67-79.)
. . . . . . so the need to predict
may explain
why we're human!
(Predict what?)
Prediction is
important in
other areas too
Consider
the weather:
the weather:
Credits:
Don Amaro from
Madeira Islands,
Portugal,
upload by Herrick
17:17, 4 December 2007 (UTC).
Http://creativecommons.org/licenses/by/2.0/
Don Amaro from
Madeira Islands,
Portugal,
upload by Herrick
17:17, 4 December 2007 (UTC).
Http://creativecommons.org/licenses/by/2.0/
Waterspout.
Credits: http://www.photolib.noaa.gov/bigs/wea00308.jpg.
1969 September 10.
Photographer: Dr. Joseph Golden,
NOAA. Public domain.
Two images of Hurricane Irma
. . . The National Weather Service (NWS)
is a large, highly technical
gov't agency devoted to
~ prediction ~
using large computers, etc.
Credits: http://www.photolib.noaa.gov/bigs/wea00308.jpg.
1969 September 10.
Photographer: Dr. Joseph Golden,
NOAA. Public domain.
Two images of Hurricane Irma
. . . The National Weather Service (NWS)
is a large, highly technical
gov't agency devoted to
~ prediction ~
using large computers, etc.
. . . It's not perfect
but it's
much better than nothing
but it's
much better than nothing
. . . weather prediction
uses computers
. . . . . . other kinds of
prediction can use
other methods
Crowdsourcing group wisdom...
Horse race betting
is an example
Source: https://www.greatfallstribune.com/story/news/2019/12/09/montana-horse-racing-board-pays-628-k-debt-state-early/2630053001
Bet right, you win $
Bet wrong, you lose $
But if you win, how much $?
It depends on how much was bet on what horse!
A crowd-sourced estimate of the odds
A kind of prediction market
Pari-mutuel betting is typical
Take all $ bet on any horse
Divide it up among bets on the winning horse
From that algorithm you can calculate odds etc.
---
For "place" bets, take all place bets
Divide half among bets on the 1st place horse
Divide other half among bets on the 2nd place horse
---
For "show" bets, take all place bets
Divide 1/3 among bets on the 1st place horse
Divide 1/3 among bets on the 2nd place horse
Divide 1/3 among bets on the 3rd place horse
Other sports betting odds are set ahead of time
Traditionally by bookies in a back room
Experts combining opinions
But not using Delphi method
Would it work better if they used Delphi method?
Prediction Market
Stock market:
Buy if expect it to go up
Were you right? Make $
Were you wrong? Lose $
Stock market is a kind of...
Prediction Market
Other ways of
looking at the
stock market
What are they?
An example from the history of this course
. . . Will the
average global temperature
for 2012
be the highest
ever recorded?
. . . at 12:23 on the afternoon before class (Sp '12):
you could have bought a "yes"
for $2.50 from intrade.com
. . . if you ended up right -
you'd get $10
. . . if wrong -
you'd lose your $2.50
What ultimately happened?
Jan 16, 2013:
NASA: 2012 Was
9th Hottest Year
on Record
As of early 2020:
- "The folly of making political prediction markets like Intrade illegal"
- ... and talk about corporate bad luck ......
Let's go to intrade.com
and check it out
- Some of their prediction graphs are still floating around the web
- E.g. https://www.aei.org/carpe-diem/recession-odds-fall-on-intrade/
- Or search images.google.com for "intrade" and look for graphs
Here are/were some other prediction markets:
- Iowa Electronic Market (IEM) - This prediction market is used for a multitude of predictions including who will be the next president. Universities also use it for research into fields like accounting, finance and economics.
- Electric (more generally, commodities) futures markets
- Predictit.org; polymarket.com
- Inklingmarkets.com; predictit.org
- Augur.net; coindesk.com
- Omen project; good judgment project
- Scicast; predictit.org
- Some from previous years
- fantex.com
- www.ipredict.co.nz
- predictit.org
- www.cultivatelabs.com
- augur.net (also see wikipedia article)
- scicast.org (can link markets, an advanced capability)
- www.predictious.com
- Åzone Futures Market
- Various sports betting companies
- Online sports betting is getting more legal in the US
Ok, here's another problem
with prediction markets
People might bet
for other reasons
than to make $
Why might someone do that?
Bet on something you don't want to happen
- If it happens anyway, you'll feel better!
Hedge a financial loss by betting it will happen
- Stock market might decline
- So, buy a bet that it will!
- Purely personal issues would not work
- Why not?
Manipulate odds to affect reality
Can you think of
a possible example?
Example:
Manipulate press coverage
of a presidential election
It's been done!
It's expensive!
Why do it?
Why should Intrade
prediction contracts
get closer to
$10 or $0,
PredictIt contracts
get closer to $1 or $0,
LR Prediction Company* contracts
get closer to $100 or $0,
etc.,
as they approach
resolution?
*???
Could price ever get
high, then end up low
(or vice versa)?
We started calling them "bets" ...
But technically it's a "prediction market contract"
- It's still a bet!
5. More about sports prediction markets
Tim Henman
serving at Wimbledon, 2005.
Credits: Photo by Spiralz, license by http://creativecommons.org/licenses/by/2.0/
. . . Sports betting has
a long history
. . . People want to
predict games
They'll pay
good money
to do it!
. . . A theoretically ideal
"honest bookmaker"
will not expect to make a profit
predict games
They'll pay
good money
to do it!
. . . A theoretically ideal
"honest bookmaker"
will not expect to make a profit
. . . . . The $$ bet are
merely redistributed
merely redistributed
. . . (But how do
real bookmakers
differ from that?)
. . . . . This is how horse racing works
6. Political prediction...
real bookmakers
differ from that?)
. . . . . This is how horse racing works
6. Political prediction...
. . .During election season,
media and candidates
all try to
predict outcomes
media and candidates
all try to
predict outcomes
. . . Some of it
you don't hear about
you don't hear about
. . . polling,
trend analysis,
sociological analysis
are big
. . . but why is
asking people
their opinion
unreliable?
trend analysis,
sociological analysis
are big
. . . but why is
asking people
their opinion
unreliable?
. . . predictions markets
have been claimed
to do it better!
. . . But they aren't perfect
have been claimed
to do it better!
. . . But they aren't perfect
- Manipulation can skew results
- People can buy predictions "irrationally"
- Example: 2012 election
7. About corporate stocks...
. . . . . . The stock market
is a
"leading economic indicator"
is a
"leading economic indicator"
. . . . . . (Economists pay
special attention to
leading indicators)
. . . . . . Is the stock market
a prediction market?
special attention to
leading indicators)
. . . . . . Is the stock market
a prediction market?
8. If someone
asked you
to invent a way
to collect
group predictive wisdom,
what might you come up with?
asked you
to invent a way
to collect
group predictive wisdom,
what might you come up with?
. . . Maybe a
Delphi-like method
Delphi-like method
. . . Probably (?) not
prediction markets
. . . . . .However, by accident,
horse racing is in that direction
prediction markets
. . . . . .However, by accident,
horse racing is in that direction
. . . . . . An early design for
prediction markets
appears in
The Shockwave Rider,
by John Brunner, 1975
prediction markets
appears in
The Shockwave Rider,
by John Brunner, 1975
. . . . . . General idea:
when real money
is at stake,
people predict better
Do you agree?
when real money
is at stake,
people predict better
Do you agree?
9. Terrorism and
prediction markets
. . . . . . DARPA's PAM
(Policy Analysis Market)
permitted a
prediction market
for terrorist attacks
(Policy Analysis Market)
permitted a
prediction market
for terrorist attacks
. . . . . . It worked like this:
How much would you pay
to get $100 if there is a
snowstorm tomorrow?
Trick 1: buy a snowstorm prediction cheap
Make a snowstorm happen, then collect $100
Similarly for a terrorist attack
Trick 2: watch for terrorism contracts
Arrest them first
. . . . . . Does that
sound like
a good idea
to you?
. . . . . . How might it
help fight terrorism?
+ we might have forwarning
- terrorists might
buy predictions, then
make them come true
to make $$$!
buy predictions, then
make them come true
to make $$$!
. . . . . . In 2003,
2 senators found out,
PAM was cancelled, and
a DARPA
program director resigned
2 senators found out,
PAM was cancelled, and
a DARPA
program director resigned
. . . . . . . . . not clear if
terrorism predictions
were ever traded
terrorism predictions
were ever traded
10. As time allows,
let's
- try our own prediction market!
Prediction market contract:
see syllabus
About how to do it, as well as some of the finer points:
let's
- try our own prediction market!
Prediction market contract:
see syllabus
About how to do it, as well as some of the finer points:
The rational participant would be willing to buy a contract for a little less than the probability of the event occurring (and thus paying off), and sell for a little more than that probability. For example if the event was a six resulting from a roll of a fair die, it would be worth buying a contract for that for $16 and selling one for $17 for a contract worth $100 (since the probability of the event is 16.67%).
To create new contracts, it works for the broker to simply lend out blank contracts for free; if the event later occurs the person taking one would have to then pay the broker $100, and if the event does not occur the contract is worthless and the broker is not paid anything.
It is an interesting point that the originator has a different risk
exposure. So they would demand a risk premium, suggesting that the
price should decline a bit over time, not because of any changes in
probabilities in the domain of the contract, but just as an artifact
of the origination risk. As the broker and proprietor of the "Little
Rock Prediction Market Co." I get to make the rules and I made them to
be useful in an in-class simulated prediction market. In a normal
semester we would be buying and selling them every week until the end
of the semester (or the event the contracts are about occurs,
whichever happens first). Then at the end of the semester I'd show a
graph of the price over time, and send everyone an email explaining
how much money they won or lost.
I could of course make bad rules, and in that case the rational
market player would play to win, leading to prices that do not reflect
the underlying probabilities.
A similar origination problem might occur with real prediction
markets - somehow the market must be primed with new contracts, and
how are they to be priced? If there are lots and lots of buyers
compared to the number of contracts, the contracts could just be sold
to the highest bidders. I can't do that in class because there aren't
enough students and also because it would be confusing to many people.
Another problem like this occurs with stock IPOs - the initial price
is just a guess (I think? Or maybe it is manipulated to be too low so
that the first purchasers have a better chance of cleaning up?) and
the price can then swing wildly at first, exposing early buyers to
increased risk. Another situation like that is when a prediction
market reaches its end. If it rapidly becomes clear what the outcome
is, the people still holding the contracts won't be able to buy and
sell them fast enough to track the events on the ground, exposing them
to the same kind of increased risk. In an extreme case, suppose the
contracts were about the outcome of a roll of the dice. The outcome
goes from pure chance to completely settled in an instant, exposing
late buyers to increased risk.
Another aspect to the market as designed for this course is it
accommodates uncertainty about the probability. For example, you might
not be confident of your estimate of 20% probability, but more
comfortable guessing that it is somewhere between 20% and 50%. Then
you would be willing to buy for $19 and sell for $51. If you were more
risk-tolerant, you might reason that the real probability is more
likely to be somewhere in the middle region than very near 20% or 50%,
so you might then be willing to buy for $25 and sell for $45, if
needed in order to execute a transaction.
Disclaimer:
Using gen-u-ine, real $10 bills would make this a very memorable learning experience. Thus, it would have educational benefit! Nevertheless, we will only pretend, because this course wishes to avoid a legal minefield of potential complications.
exposure. So they would demand a risk premium, suggesting that the
price should decline a bit over time, not because of any changes in
probabilities in the domain of the contract, but just as an artifact
of the origination risk. As the broker and proprietor of the "Little
Rock Prediction Market Co." I get to make the rules and I made them to
be useful in an in-class simulated prediction market. In a normal
semester we would be buying and selling them every week until the end
of the semester (or the event the contracts are about occurs,
whichever happens first). Then at the end of the semester I'd show a
graph of the price over time, and send everyone an email explaining
how much money they won or lost.
I could of course make bad rules, and in that case the rational
market player would play to win, leading to prices that do not reflect
the underlying probabilities.
A similar origination problem might occur with real prediction
markets - somehow the market must be primed with new contracts, and
how are they to be priced? If there are lots and lots of buyers
compared to the number of contracts, the contracts could just be sold
to the highest bidders. I can't do that in class because there aren't
enough students and also because it would be confusing to many people.
Another problem like this occurs with stock IPOs - the initial price
is just a guess (I think? Or maybe it is manipulated to be too low so
that the first purchasers have a better chance of cleaning up?) and
the price can then swing wildly at first, exposing early buyers to
increased risk. Another situation like that is when a prediction
market reaches its end. If it rapidly becomes clear what the outcome
is, the people still holding the contracts won't be able to buy and
sell them fast enough to track the events on the ground, exposing them
to the same kind of increased risk. In an extreme case, suppose the
contracts were about the outcome of a roll of the dice. The outcome
goes from pure chance to completely settled in an instant, exposing
late buyers to increased risk.
Another aspect to the market as designed for this course is it
accommodates uncertainty about the probability. For example, you might
not be confident of your estimate of 20% probability, but more
comfortable guessing that it is somewhere between 20% and 50%. Then
you would be willing to buy for $19 and sell for $51. If you were more
risk-tolerant, you might reason that the real probability is more
likely to be somewhere in the middle region than very near 20% or 50%,
so you might then be willing to buy for $25 and sell for $45, if
needed in order to execute a transaction.
Disclaimer:
Using gen-u-ine, real $10 bills would make this a very memorable learning experience. Thus, it would have educational benefit! Nevertheless, we will only pretend, because this course wishes to avoid a legal minefield of potential complications.
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