In Paul Krugman’-s blog entry, Done, at 4:39pm (EDT) on March 21, 2010, he commented: “-OK, nothing is sure in this world. Intrade is still giving Obamacare a 2.2% chance of failing, …”-
He was talking about the InTrade market on Health Care Reform. In theory, the market price in such a derivative market should equal the expectation of the underlying event coming true. However, Paul Krugman (and many others) forgot one of the most basic assumptions of the market model! Transaction costs.
When the market price is over 95, InTrade charges a transaction fee of 3 cents per contract (real money). While market prices are quoted in percentages, the payoff for a winning ticket is $10 (real money). Therefore, the transaction fee is 0.3% of the winning payoff. In addition, InTrade charges 10 cents per contract on expiry (if you “-win”-). That’-s another 1.0%.
So, when the market was quoting 97.8% likelihood of the HCR bill passing before June 2010, this didn’-t really mean that there was a 2.2% chance of the bill not passing. A winning ticket would be subject to 1.3% transaction fees. The real likelihood of failure was 0.9% –- approximating the uncertainty that Obama would be “-hit by a bus”- before signing the bill into law.
No rational investor would wish to purchase a share for more than 98.7, given the transaction costs. In a sense, this is the market’-s “-100%”-. Interestingly, at 1:49pm GMT today (March 23), there are 695 bids at 99.1 and 413 asks at 99.2. Clearly, some traders are not subject to the full transaction fees at InTrade. More about that here.
[Cross-posted from Toronto Prediction Market Blog.]
This is really stupid. The decerebrated journalos at the FT chose to feature the illiquid, Ireland-based, un-regulated InTrade prediction markets instead of the very liquid, UK-based, regulated BetFair prediction markets on the next British congress.
Makes no sense at all.
The BetFair PR boys have an omelet on their face. They should work harder.
DISAMBIGUATION: The “-illiquid”- adjective refers to the UK political markets on InTrade —-not the US political prediction markets.
Don’-t be fooled by any “-research scientist”-. 
Business Insider cites various InTrade probabilities.
Can I choose my style of odds?
We show percentage odds by default, but you can select the odds display of your choice from the top of every page. We offer American, fractional, decimal and percentage odds. Because we allow fans to set their own odds you may see some strange looking fractional or American odds, we recommend percentage odds as we think they are the most flexible and readable choice.
Does anybody (in Great Britain or elsewhere) disagree with that? Explain your view in the comments.
I do agree with Smarkets.
PaddyPower is a bookmaker, not a prediction exchange. Hence, the Tiger Woods divorce cost odds are computed by an analyst, not by the market.
1. It is not the “-punters”- who have fabricated the odds, but a PaddyPower employee.
2. It is not a set of “-market odds”-, but a set of bookmaker odds.
3. The bookmaker analyst does not have access to any confidential contract. So, the PaddyPower press release is aimed at suckers in the media.
I’-m puzzled by the way Intrade projects the electoral vote count on its home page. Two methods are proposed: (a) add up the votes of all the states that are “-leaning”- (>-50%) for a candidate, or (b) compute a price-weighted average. The latter is obviously meaningless because electoral votes are winner-take-all in pretty much every state.
But what about the “-leaning”- method? Well, it only makes sense if you believe that market prices do not represent probabilities. In fact, the “-leaning”- method treats the 15 electoral votes from a swing state like North Carolina (65% chance to go blue) the same way it treats the 15 votes from a true-blue state like New Jersey (95% chance to go blue), tossing them both equally in the Obama column.
Now, Intrade has been known to want it both ways: interpreting its prices as probabilities most of the time, but then also claiming that it correctly predicted all 50 states in 2004 because all the contracts priced over 50% eventually expired at 100%. This claim conveniently ignores the fact that if prices are probabilities, then at least some of the states priced “-red”- or “-blue”- over 50% should in fact have gone the other way on election day.
It may very well be that, given the 2004 data, the prices of election markets (on Intrade and elsewhere) should not be interpreted as probabilities. Perhaps our academic friends can come up with another meaningful way of looking at those prices. But in the meantime, assuming the price/probability correlation holds, the proper way to project the electoral vote count from the market prices is to run monte-carlo simulations based on individual state prices.
Here’-s an example using this morning’-s prices on NewsFutures. The histogram shows the results of 1 million simulated elections where each state goes red or blue according to its market-derived probability of doing so. Note how the “-most likely”- outcome, 364 votes for Obama – which is the number the “-leaning”- method would report – is at the same time very unlikely with just 5% chance of happening.
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#1. Explainer On Prediction Markets
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Prediction markets produce dynamic, objective probabilistic predictions on the outcomes of future events by aggregating disparate pieces of information that traders bring when they agree on prices. Prediction markets are meta forecasting tools that feed on the advanced indicators (i.e., the primary sources of information). Garbage in, garbage out…- Intelligence in, intelligence out…-
A prediction market is a market for a contract that yields payments based on the outcome of a partially uncertain future event, such as an election. A contract pays $100 only if candidate X wins the election, and $0 otherwise. When the market price of an X contract is $60, the prediction market believes that candidate X has a 60% chance of winning the election. The price of this event derivative can be interpreted as the objective probability of the future outcome (i.e., its most statistically accurate forecast). A 60% probability means that, in a series of events each with a 60% probability, then 6 times out of 10, the favored outcome will occur- and 4 times out of 10, the unfavored outcome will occur.
Each prediction exchange organizes its own set of real-money and/or play-money markets, using either a CDA or a MSR mechanism.
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More Info:
– The Best Resources On Prediction Markets = The Best External Web Links + The Best Midas Oracle Posts
– Prediction Market Science
– The Midas Oracle Explainers On Prediction Markets
– All The Midas Oracle Explainers On Prediction Markets
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#2. Objective Probabilistic Predictions = Charts Of Prediction Markets
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Put your mouse on your selected chart, right-click, and open the link in another browser tab to get directed to the prediction market page of your favorite exchange.
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2008 US Elections
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InTrade
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2008 US Electoral College
2008 Electoral Map Prediction = InTrade – Electoral College Prediction Markets = Probabilistic predictions for the 2008 US presidential elections based on market data from InTrade = electoralmarkets.com
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– This is a dynamic chart, which is up to date. Click on the image, and open the website in another browser tab to get the bigger version.
