“-Thrutch”-:
Probabilities, Prediction Markets, and Popular Fallacies
With Hillary’-s surprise victory over Obama in the New Hampshire primary, pundits everywhere are decrying the allegedly ‘-wrong’- odds that prediction markets like Intrade were displaying prior to the announced results. (As just one example, Barry Ritholtz weighs in with his ‘-explanation’- of : “-Why Opinion Markets Fail“-.)
At one point the betting markets were implying over a 90% probability for Obama to win. Does this mean they were ‘-wrong’-? No it does not. It is impossible to judge whether a given probability is/was correct based on the outcome of a single event.
A 90% probability simply implies that, if you encounter a series of events each with a 90% probability, then 9 times out of 10, the favored outcome will occur- and 1 time out of 10, the unfavored outcome will occur. Those like Ritholtz who are now calling the prediction markets ‘-wrong’- are implying the following: if the probability is 90% for an outcome to occur, then that outcome should occur every time. In other words, if the odds are 90% in favor of something —- it should happen 100% of the time! But this is obviously fallacious. If the outcome occurs 100% of the time, then the correct probability to assign to it would be 100% —- not 90%.
To validly assess the accuracy of prediction markets, one needs to aggregate all the situations where the odds were 90%, and then calculate whether the favored outcome indeed occurred 90% of the time. (And do the same with each level of probability.) This —- and only this —- will tell you how accurate prediction markets tend to be.
Barry Ritholtz:
As every good prognosticator knows, if you couch your forecasts in probabilities, the innumeric will never know you were wrong. It’-s a cheap trick for the easily fooled.
Imagine if instead of a “-THE END IS NEAR”- sign, every loon carried a sign that proclaimed:
THERE IS A 57% CHANCE THAT THE END IS NEAR!!!
The fact that this didn’-t happen —- and the 43% probability did —- doesn’-t mean this forecast was accurate. It merely meant that the person had proferred two possibilities and one of those two occurred. But the math remains unverified.
Neat trick: By your definition, PREDICTION MARKETS CAN NEVER BE WRONG, so long as they maintain a 1% possibility of the alternative outcome.
That’-s hardly a satisfying defense…-
Author Profile -Editor and Publisher of Midas Oracle .ORG .NET .COM —- Chris Masse’-s mugshot —- Contact Chris Masse —- Chris Masse’-s LinkedIn profile —- Chris Masse’-s FaceBook profile —- Chris Masse’-s Google profile —- Sophia-Antipolis, France, E.U. Read more from this author…-Read the previous blog posts by Chris. F. Masse:
- Good news: The BetFair blog now features a prediction market column. — Bad news: Their columnist is an anonymous writer with long hair… and dubious skills.
- Once again, a BetFair spin doctor misunderstands the prediction market approach.
- Grandizer
- Tss… Tss… Surely, you are joking Doctor Giberson.
- Comments are still open on Midas Oracle.
- “I am much more aligned with InTrade than you are, Chris.”
- And the award for the most technology advanced software vendor goes to… the envelope, please…. QMARKETS in Israel. … [Cheers and applauses in the crowd.]