tag:blogger.com,1999:blog-4039434.post6025488867414285248..comments2024-02-26T06:46:53.171-05:00Comments on Rajiv Sethi: Death of a Prediction MarketRajivhttp://www.blogger.com/profile/13667685126282705505noreply@blogger.comBlogger12125tag:blogger.com,1999:blog-4039434.post-30174733599248291472012-11-29T19:05:57.527-05:002012-11-29T19:05:57.527-05:00Great! So maybe we can plan for January.Great! So maybe we can plan for January.Bilgehttps://www.blogger.com/profile/13988242742655257583noreply@blogger.comtag:blogger.com,1999:blog-4039434.post-39922989342093378092012-11-29T18:40:53.337-05:002012-11-29T18:40:53.337-05:00I'm on leave next semester, visiting Microsoft...I'm on leave next semester, visiting Microsoft Research, but will be in New York so we could certainly meet. Rajivhttps://www.blogger.com/profile/13667685126282705505noreply@blogger.comtag:blogger.com,1999:blog-4039434.post-32944860830020314632012-11-29T18:37:05.381-05:002012-11-29T18:37:05.381-05:00Thanks for the interesting discussion. I agree wit...Thanks for the interesting discussion. I agree with your last point. The channels through which speculation changes equilibrium outcomes differ according to the markets in question, and the effects may be temporary or permanent again according to the market. <br /><br />By the way, will you be around for the Spring semester soon? Would be wonderful to catch up with you!Bilgehttps://www.blogger.com/profile/13988242742655257583noreply@blogger.comtag:blogger.com,1999:blog-4039434.post-64208193588456157652012-11-29T18:09:16.065-05:002012-11-29T18:09:16.065-05:00Thanks Bilge, these are interesting effects. There...Thanks Bilge, these are interesting effects. There's a tight link between sport and futures prices in any case through the spot-futures parity theorem, violation of which implies an arbitrage opportunity. But the effects you have in mind can lead to bubbles and excess volatility in spot and futures markets simultaneously. <br /><br />I still think that credit default and prediction markets are different because speculation can have permanent effects by affecting which of multiple equilibria are selected. Rajivhttps://www.blogger.com/profile/13667685126282705505noreply@blogger.comtag:blogger.com,1999:blog-4039434.post-59154533309694938492012-11-29T16:52:33.822-05:002012-11-29T16:52:33.822-05:00Rajiv, thanks so much for your comment. I agree wi...Rajiv, thanks so much for your comment. I agree with you that usually in commodity markets higher prices lead to lower demand and increased supply, thus correcting the short-run deviation. Recently the financialization of commodity futures markets raised the question of whether there can be positive feedback affects running from futures prices to spot prices. For example, Xiong and Sockin argue that if "industrial producers across the world use futures prices of oil and copper as signals of the strength of the global economy, an increase in the futures prices, even if driven by<br />non-fundamental factors, may lead industrial producers to increase, rather than decrease, commodity demand, which in turn can cause spot prices of these commodities to rise. Such feedback effects thus motivate a re-examination of the aforementioned economic arguments." (http://www.princeton.edu/~wxiong/papers/feedback.pdf). <br />There has been also Keynesian arguments, including Ghosh, Heintz and Pollin, who wrote: "One indicator that futures prices are influencing spot prices is a build-up of inventories when both<br />spot prices and futures prices are increasing. The reasoning is straightforward: if suppliers in spot markets expect prices to increase in the future, they may withhold their products from the market in order to profit from higher prices in the future (the amount withheld depending on storage costs and discount rates). The withdrawal of supply then pushes up prices in spot markets. Note that a build-up of inventories when spot prices are increasing must be driven by expectations, and not fundamental<br />shifts in supply and demand. The explanation for increasing inventories during times of rising prices is that prices are expected to be even higher in the future." (http://www.peri.umass.edu/fileadmin/pdf/working_papers/working_papers_251-300/WP269.pdf)<br />These are just some examples. So I see a similarity to the effects of speculative manipulation in prediction markets and speculative trading in commodity markets, although they work through different channels, as you pointed out.Bilgehttps://www.blogger.com/profile/13988242742655257583noreply@blogger.comtag:blogger.com,1999:blog-4039434.post-75253522993100520292012-11-29T14:43:24.595-05:002012-11-29T14:43:24.595-05:00Very good. The point gets made regardless.Very good. The point gets made regardless.THHhttps://www.blogger.com/profile/00999429817111711817noreply@blogger.comtag:blogger.com,1999:blog-4039434.post-80781904094500414142012-11-29T14:34:42.398-05:002012-11-29T14:34:42.398-05:00Bilge, in commodity markets the feedback from pric...Bilge, in commodity markets the feedback from prices to fundamentals is usually negative: higher prices induce lower demand and increased supply, which should lower future prices. Short-run manipulation and bubbles are still possible but can't really be sustained for very long. <br /><br />Credit markets are different, a sharp rise in the cost of borrowing can make a debtor more likely to default, thus justifying the rise in the cost of borrowing. Multiple equilibria are possible here, which makes manipulation (or self-fulling bear raids as they are sometimes called) potentially profitable even in the long-run.<br /><br />Prediction markets are like credit markets in this respect. Inflating the possibility of victory can cause fundraising and morale to rise, thus increasing the objective likelihood of victory. This effect is discussed in more detail <a href="http://rajivsethi.blogspot.com/2010/01/on-prediction-markets-and-self.html" rel="nofollow">here</a>.Rajivhttps://www.blogger.com/profile/13667685126282705505noreply@blogger.comtag:blogger.com,1999:blog-4039434.post-14558603604941347222012-11-29T13:00:33.714-05:002012-11-29T13:00:33.714-05:00Thanks for this very interesting discussion of pre...Thanks for this very interesting discussion of prediction markets. I find the possibility of positive feedback between prices and objective probabilities, and the resulting profits from manipulation quite interesting. It has been also a point made by researchers working on commodity markets that any large speculative position taking through index investment can signal that prices are likely to rise (or fall) in the future, which can change the objective probabilities, and thus create profit opportunities for very large index investors. And there are also prediction markets for commodities like gold or oil. So one question I have is do you think that prediction markets in commodities do help price discovery, and by doing so, improves public benefit? Or, do you think that it is more difficult to catch manipulation in these markets, which creates profit for investment bankers and losses for consumers of commodities that have inelastic demand for them?<br />Bilgehttps://www.blogger.com/profile/13988242742655257583noreply@blogger.comtag:blogger.com,1999:blog-4039434.post-25110479935602502792012-11-29T11:35:40.013-05:002012-11-29T11:35:40.013-05:00Yes, I did know that and thought about using "...Yes, I did know that and thought about using "forest" initially but decided against it because "wood for the trees" just sounds much nicer to me. <br /><br />I'm hoping that in this increasingly globalized world the correlation between expressions and geography/culture will break down a bit. This is a tiny contribution to that effort. <br /><br />Another expression that is better in the original is "till death us do part" in wedding vows. The American version, "till death do us part" is much less poetic. Rajivhttps://www.blogger.com/profile/13667685126282705505noreply@blogger.comtag:blogger.com,1999:blog-4039434.post-47518004059484562352012-11-29T11:15:02.114-05:002012-11-29T11:15:02.114-05:00The American aaying is can't find the forest f...The American aaying is can't find the forest for the trees. Hard to keep those straight. I have an Indian co-worker who has some hilarious variations.THHhttps://www.blogger.com/profile/00999429817111711817noreply@blogger.comtag:blogger.com,1999:blog-4039434.post-36379933362643419572012-11-28T22:26:54.387-05:002012-11-28T22:26:54.387-05:00Ronald, marking to market would not work in Intrad...Ronald, marking to market would not work in Intrade because many contracts have a positive probability of immediate expiry. For instance, a coup in Syria would result in all three Assad contracts expiring at 100 right away, and the exchange needs to ensure that those with short positions can pay up. For the election contracts, scandal, illness or death could have had such effects. Margin has to cover worst case loss from the outset. <br /><br />The markets are popular with students because they can easily compare prices with their own subjective probabilities of public events, and think about whether a contract is fairly priced. It takes a lot of research to figure this out for stocks an bonds. They can compute risk and return easily since there are only two outcomes. And they can understand arbitrage by comparing complementary contracts or thinking about replication of portfolios using different sets of contracts. It's not the thinness of the markets that matters here it's the simplicity of the binary option and its relation to familiar events. <br /><br />Regarding efficiency, an important issue that arises with prediction markets is the possibility of positive feedback between prices and objective probabilities (discussed <a href="http://rajivsethi.blogspot.com/2010/01/on-prediction-markets-and-self.html" rel="nofollow">here</a> for instance). This makes manipulation potentially profitable and efficiency hard to define.Rajivhttps://www.blogger.com/profile/13667685126282705505noreply@blogger.comtag:blogger.com,1999:blog-4039434.post-26474288827745952022012-11-28T21:57:04.366-05:002012-11-28T21:57:04.366-05:00Hi Rajiv,
Given that this is a democratization of...Hi Rajiv,<br /><br />Given that this is a democratization of previously highly (in both senses) controlled financial markets, it makes sense that regulation can be equally serious. <br /><br />The questions you raise fall back on the "call money" problem of the 1930s. Since then, traders margin up with a settlement house marked to market. <br /><br />Etc. Sounds like what Intrade should have been doing.<br /><br />A propos, isn't it possible that one reason the markets are so popular with your courses is their arithmetic variability? In thin markets lots of features are more visible.<br /><br />A double propos: have you any thoughts or measures regarding _efficiency_ in these markets.<br /><br />En pointe, perhaps you are shedding crocodile tears like Dr. Bell after Jack the Ripper left town. Or, you are dissuading us as a cabal of financiers including like Sheldon Abramson and Donald Trump is setting up a U.S. intrade. Sort of like the NYSE, to Intrade's Amex?Ronald Calitrihttps://www.blogger.com/profile/07206853993777529429noreply@blogger.com