We have often discussed the possible benefits of prediction markets for reducing bias. One key element that could be particularly useful is a conditional prediction market, where betting claims are based on outcomes conditional on some factor we want to evaluate. Robin recently mentioned the possible benefit from market claims on longevity or health conditional on various interventions.

Unfortunately, there are few prediction markets in the world, and fewer conditional ones, so it is hard to know how practical this institution may become. Thanks to an initiative by OB contributor Peter McCluskey, Intrade – the large, real-money prediction market – has added conditional claims based on the outcome of the U.S. Presidential elections. These may represent the first major case study of real-money conditional futures markets. So how are they doing? Here is some data and analysis.

Because of how the conditional claims are computed, we need to normalize the results by dividing the claim prices by the probability of a win for that party’s candidate. At the moment I looked (2008-07-28, 5:00 PM PDT), clicking on Politics and “2008 US Election”, and expanding “2008 Presidential Election Winner (Political Party)” I saw that the odds for a Democratic victory are 66.7-67.4. The claims are based on Democratic vs non-Democratic victories, so we will use the complementary odds of 32.6-33.3 for a non-Democratic win.

Then clicking on the left on “US Pres. Decisions” gives us the six conditional markets funded by Peter McCluskey.

Here are the claims, the prices, and the normalized values found by dividing by the corresponding Democratic and non-Democratic victory probabilities above. To compute the normalized values, I divided the lowest claim price by the highest party-victory price, and the highest claim price by the lowest party-victory price, giving the maximum range consistent with current trading prices. (Peter provides continually-updated information on current implied values as well.)

Claim Dem price non-Dem price Dem norm non-Dem norm Increase in US government debt (over $10 billion) 51.2-53.7 34.4-36.5 76.0-80.5 105.5-109.6 Number of US troops in Iraq on 30 June 2010 (over 2000) 41.3-43.8 32.1-34.3 61.3-65.7 96.4-105.2

These prices imply that the market expects that under a non-Democratic administration, we will see substantially higher government debt, as well as much higher numbers of soldiers in Iraq.

In addition, there are two claims based on the chance that futures prices will move in the same direction as the Democratic party victory claim price, on election day:

Claim Odds Oil Futures & PRESIDENT.DEM2008 prices will move in same direction on Election Day 49.8-49.9 T-Bond interest rate futures & PRESIDENT.DEM2008 prices will move in same direction on Election Day 49.9-50.1

These values are so close to the 50% mark that it appears that the markets do not expect any significant movement in oil prices or interest rates on election day, that can be attributed to developing information about which party will win. As critics have noted, this could be because they don’t see much effect of political parties on these values, or else because they expect that the election day results will be a foregone conclusion and there will be no surprises in that regard. (Or perhaps, that no significant information will leak out regarding election results during trading hours.)

Intrade has another set of conditional election claims under the heading of “Impact of Next Pres.”. Rather than party based, these claims are linked to specific candidates, meaning that at this point only the Obama and McCain claims have significant relevance. The claims measure economic growth, unemployment, crime, and control of the legislature, conditional on candidate victory – all interesting topics. But there is a huge difference in liquidity and trading volume for these claims versus the ones discussed above. These claims have bid-ask spreads that range from large to enormous; some have no bid or ask offers at all. And the trading volume is so far non-existent – apparently none of them has ever traded! These claims are essentially useless for shedding light on likely impacts of the presidential choice.

So what is the difference? The first set of claims is being funded and subsidized by Peter McCluskey, who has set up an automated market maker algorithm (based on an invention by Robin Hanson) that keeps the bid-ask spread within 2.5 points. When I first heard of the idea of such a bot, I thought it would have to be willing to lose infinite amounts of money, but actually this is not the case; losses are bounded. Nevertheless the potential costs to Peter are very significant, and he could be out almost $50,000 to fund his six claims.

Still, we can see the very real and practical benefits of this subsidy approach. The claims sponsored by Peter have relatively good liquidity and produce meaningful price comparisons. While not intrinsically more interesting than the other batch, Peter’s claims trade relatively frequently since there is always an attractive offer, while the others have never traded at all.

The lesson, then, is that conditional prediction markets can be informative, but that there is great importance in the detailed structure of the institutions. Peter’s subsidies have made the difference between a failed market and a successful one. At the same time, we see that the claims based on price movements on election day are not working as well as the others, so that idea may not be as promising (perhaps circumstances will change as election day approaches).

Another issue I would see as a potential trader is the difficulty of protecting my position against shifts in prices of two different markets. The value I am betting on is the ratio of two sets of prices, so I may want to change my holdings if either of those prices moves. It would be nice if one could post bids which are based on the ratio rather than on specific prices in the individual markets. It would also be nice to see the imputed values based on price ratios live and next to the market prices, rather than on another web page.

Even with these problems, it appears that the overall concept is a rather spectacular success that suggests that the concept has great promise. We all owe a debt of thanks to Peter for making such a substantial contribution towards showing the practicality of conditional futures markets.

GD Star Rating

loading...