David Leonhardt weighs in. The other day John Nye and I were discussing that de facto limits on the size of effective bets are the biggest problem hindering effective price discovery. When you can become a millionaire on InTrade, that’s when its prices will become much better forecasters. Nonetheless I agree with the piece’s conclusion:

If you have any better ideas of where to look, let me know.

But some inefficiencies need to be taken with a grain of salt:

Mr. Ravitch has made a nice profit betting against Ron Paul,

the libertarian who late last year was, amazingly, given almost a 10

percent chance of becoming the Republican nominee. “If you asked anyone

in politics whether there was ever, at any point, a 10 percent chance

of Ron Paul being the nominee,” Mr. Ravitch said, without finishing the

sentence. “That sort of makes my case for me.”

When it comes to the long shots, remember that InTrade takes deposits in non-interest-bearing cash rather than T-Bills. In the meantime observers need to adjust their expectations accordingly and not interpret all the prices are pure percentages. I recall Paul trading at about 7 or 8 percent. Let’s say you shorted Paul last December. You’re locking up your cash for quite a while at zero percent interest and when Paul fails you’re not going to net as much as you thought. In other words, there is a partial short sale constraint on this market and its prices need to be understood accordingly.

Of course there is a reason why InTrade insists on earning the float and that directs our attention back to the zero-sum property of the bets. That’s another reason why prediction markets probably won’t ever forecast as well as the stock market: their users have to be charged or taxed at a higher rate. The expected rate of return in InTrade is negative; the expected rate of return in the stock market is seven percent minus commissions. Where would you rather put your smarts to work?