One question that often comes up is how to encourage participation in long-term, multi-year event markets. This issue is closely linked to cost of capital, and even play-money markets have opportunity costs and discount rates.
If the outcome is revealed gradually, as with questions about the global climate, offering a series of short-term levered contracts should help. This is not entirely satisfying though because it could be viewed as just increasing the noise in traders’- p&-l —- although the traders with correct long-term views will do well, and the greater magnitude of the p&-l will attract more traders and keep them interested in the market.
There is just no way to settle a contract today for an event that will happen tomorrow. The most important thing you can do is to minimize the capital required to be committed to the distant event. For instance, traders may be compelled to only post or freeze a fraction of their worst-case loss, although this gets tricky if the contract will likely be resolved in a sudden, drastic jump. In this respect, questions about the climate are more tractable than ones concerning technological breakthroughs, for example. In many cases it may be better to use index futures instead of a binary options.
Most importantly perhaps, remember that most of what “-prediction”- markets do is just aggregating and discounting current information. Therefore ask yourself if anyone feasibly possesses information pertinent to the distant event. There may be nothing to aggregate. It may still be worthwhile to set-up a market because you’-re not sure when someone will learn something relevant, but it is probably undesirable to try to force participation, even for very important questions.
Read the previous blog posts by Jason Ruspini:
- 2009 tax futures yielding 1.5%
- Intrade, with carry
- Talking tax futures on BNN, Canada’s business channel
- Tax Futures, “In Real Life”
- How to sell art short
- YooNew, fears and hopes
- Policy Event Derivatives
One of the most insightful blog posts I have read on Midas Oracle so far.
Long-term questions are just harder questions, not just for prediction markets but for other institutions as well. I don’t see clever technical solutions, like lowering margin requirements, making them much easier.
If a long term question is important enough to you, then you will be willing to spend what it takes to entice participation in the best method available for info aggregation. And that best method may well be prediction markets.
I followed the link, but I didn’t see a detailed description of “series of short-term levered contracts” that told me how this would address the problems. If the assets in the series have to be separately purchased, then holding an earlier one doesn’t provide access to the later market. If each near term asset pays off with one with a later expiration, it looks like a long-term market, and I don’t see how this resolves the inherent problems.
There are a few problems with long-term claims, including at least attention, settlement and inflation. If you try to replace one long-term claim with a series of shorter term claims, you magnify the settlement issues. Robin has described how to back the payout with an appreciating asset to handle concerns about inflation and relative devaluation of the underlying assets. That leaves attention as the major concern. Other than having an ongoing community (which FX does), and interesting questions, I don’t know what to do.
What other problems have people identified?
Whether it’s a series of binary contracts or a long-term index future, reducing margin requirements will address the most significant opportunity cost in these markets. This has its own problems as mentioned, especially if the market’s returns will likely be skewed, i.e. if the proposition is inherently more binary than the global climate example. Yes, in those cases a series of contracts might not help, and the question might not be readily expressible with an index, but maybe that’s part of an answer – try to couch long-term propositions in less binary terms so they will be more tractable to levered contracts.
It does seem that the kinds of questions that corporations are concerned with are largely not binary, and can be indexed.
There is also a distinction to be made between rewarding traders for revealing information vs. rewarding them for new research and innovation. A functioning real-money market would do a lot to capture the attention of the latter group of traders.