Thursday, January 17, 2008
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Old-time prediction markets
In my latest Marketplace commentary, I pointed out that the accuracy of prediction markets would improve as they went more mainstream. Essentially, as markets widen and deepen, their informational efficiency should improve.
I had assumed that we would need to wait for the future for this to happen. However, Paul Rhode and Koleman Strumpf provide some fascinating evidence from the past in thieir paper, "Historical Presidential Betting Markets." The highlights:
This paper analyzes the large and often well organized markets for betting on presidential elections that operated between 1868 and 1940. Over $165 million (in 2002 dollars) was wagered in one election, and betting activity at times dominated transactions in the stock exchanges on Wall Street.Hat tip: The Monkey Cage's John Sides. posted by Dan on 01.17.08 at 05:58 PM
and yet, and yet... even perfectly efficient, rational prediction markets can only process the information that is actually out there. The most efficient markets out there can't reduce the inherent uncertainties of life; they are not soothsayers.
We've witnessed a great example of this over the last couple of weeks, in the reactions of the political prediction markets to the recent events in Democratic presidential primaries. I was watching them closely, to see whether they could add any real predictive value, and the answer was a resounding "no." Before Iowa, Hillary was the favorite; after Iowa, Obama shot up to become the favorite; after New Hampshire, Hillary shot back into the lead. The graphs of the candidates look like an EKG, and with good reason: the people betting had the same information as everybody else, were reading the same polls and analyses, etc. The markets, in short, behaved like a second-rate pundit on CNN-- they expressed whatever the conventional wisdom of the moment happened to be, with a lag time of a few hours.
Sure, whatever the outcome of the race eventually is, the markets will have "predicted" it at some point beforehand, but so will Jeff Greenstein--along with every other outcome that seemed likely on a given day but never panned out.
This is the political equivalent of the Heisenberg Uncertainty Principle. If nobody has noticed this and coined a political version of the term, then I will lay claim to it now and call it the Sixpack Uncertainty Principle.
Heisenberg Uncertainty Principle: locating a particle in a small region makes the momentum of the particle uncertain, and conversely, measuring the momentum of a particle precisely makes the position uncertain.
Sixpack Uncertainty Principle: measuring the political support for a candidate and publishing the poll results makes the candidate's momentum uncertain (due to effect of the poll on public opinion), and conversely, measuring the momentum of a candidate makes determination of the candidate's political support uncertain due to claims of momentum upon the opinion polls.posted by: Joseph Sixpack on 01.17.08 at 05:58 PM [permalink]
Cheers and regardsposted by: Frank on 01.17.08 at 05:58 PM [permalink]
Prediction Markets? Just another way of saying "ad hoc bookmakers." Considering the Rhode and Strumpf paper--I think it would have benefitted from further incorporation of mathematical factors. Sometimes, even in economics, basic math must be used to really see what is happening. There are too many variables unexplored or unaccounted for in their four points.
Frank--Jonah Goldberg a "hack?" Really, that's pretty inaccurate. Question: Have YOU read Goldberg's book? Why is it important to you what Dr. Drezner thinks about it? Read it and think for yourself.posted by: Useless Sam Grant on 01.17.08 at 05:58 PM [permalink]
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