Prediction Markets Have Arrived!

Donald Luskin writes:

There is now no question whatsoever that the Bush re-election futures contract at Tradesports.com is being manipulated. Yesterday the price of the futures were sold down from about 55 (indicating the market’s estimate of a 55% probability of Bush’s re-election) to 10 (indicating a 10% probability) with a single 10,000-lot order entered by a single trader. An order that size represents twice the normal volume of an entire typical day’s trading. Within moments after the order was completed, the price recovered back to the low-mid-50’s.

According to sources at Tradesports, yesterday’s order was entered by the same individual who has heavily sold the Bush futures three times over the past month. The first instance was on September 14, when this trader sold the futures down from the mid-60’s to 49.6. The second instance was in the middle of the second presidential debate on October 8, when the futures were sold down from the high 50’s to 51.5. The third instance was right after the third presidential debate on October13. As the debate began the futures were priced at 57, and by the end of the debate they had risen to 60. Then a few moments later they were beaten down to 54 in a matter of minutes.

Luskin hints that George Soros might be at work. Wouldn’t that be cool! What I see as most interesting is a) an order twice the normal volume of an entire day’s trading had virtually no influence on the market price and b) prediction markets are now so widely followed that someone finds it worthwhile to try to manipulate them.

Should Luskin be worried that his candidate is being sold down? Not at all. A surprising result in these markets is that manipulators subsidize information traders. Think about it this way, by definition manipulators aren’t trying to predict the true outcome so they are likely to take losses and the more they try to manipulate the bigger the losses. Now if the manipulators are taking losses who is making money? The information traders! Manipulators, therefore, encourage and support the information traders. Manipulation isn’t impossible but it’s surprising how little information other trader’s need to not only avoid the manipulation but to profit from it.

Our colleague, Robin Hanson, has written a paper explaining the theory (warning, not for the mathematically faint hearted) and an experimental paper showing that the theory works in practice.

Thanks to Newmark’s Door for the link.