Comments on: More on the Iowa Electronic Markets

By: Positive Liberty » Blog Archive » On Cardinals, Markets… and the Mighty Uruk-Hai

Thu, 06 Oct 2005 12:28:28 +0000

[...] An example of this comes from the Iowa Electronic Markets futures trading for the 2004 U.S. presidential election, an experiment which failed to predict anything at all before it became screamingly obvious. Worse, the IEM even seems to have had some very deep structural inefficiencies that a really smart trader could have taken advantage of. [...]

By: Patri Friedman

Patri Friedman — Fri, 10 Sep 2004 07:32:23 +0000

Over at Catallarchy, I’ve blogged a comparison of markets and crowd polling as opinion aggregators. I think this explains why IEM is not efficient, and why Tradesports and similar markets still can be.

By: dsquared

dsquared — Thu, 09 Sep 2004 15:46:27 +0000

Mats: it was zero on the precise occasion when I typed that. I’ve seen mid-single digit negative rates on the bids on a couple of occasions in the past; the -20% is almost certainly a figment of the data. Alex: In many ways I agree with you, though the option analysis is interesting because it shows that the pricing anomaly in the package is entirely concentrated in the DEM04 contract. This is quite interesting from the point of view of the sociology of the IEM, because I think that’s the market’s way of telling us that DEM04 is a superfluous contract; since being short one contract is equivalent to being long the other, it looks to me as if REP04 is the one that gets priced sensibly, and DEM04 just floats around. My advice to the IEM people would be to not divide up the liquidity pool in this way and only have an INCUMBENT04 contract.

By: Mats

Mats — Thu, 09 Sep 2004 11:36:40 +0000

DD: “[including bid-ask spreads does not] make a qualitative difference.” Well yes, if you don’t think there is a qualitative difference between borrowing a dollar at double digit negative interest rate and borrowing it at zero, as in your example. Besides, as noted above, order depth is really so so. My feeling is that you would probably earn more as a marketmaker than an arbitrageur on these betting exchanges.

By: globecanvas

globecanvas — Thu, 09 Sep 2004 05:02:36 +0000

I agree with Alex’s summation. Putting on a synthetic short is at least two transactions, and people come to IEM to buy their dreams, not to buy the world and sell back their nightmares.

By: Alex

Alex — Thu, 09 Sep 2004 04:31:46 +0000

” one’s seen fit to equate it to neglecting the cost of Kerry?” ba dum bum. I re-read this post and I suspect more and more the question is being overcomplicated by unnecessary option analysis. I would bet a similar study of the market-settled package would yield a similar “negative carry” for the basic reason that newcomers to market tend simply to buy or bid one or the other contract instead of buying the package and selling an unwanted overpriced component. Hence the package is routinely priced 1 or 2 cents over parity purely by accident, yielding the observed ‘negative carry.’

By: Sven

Sven — Thu, 09 Sep 2004 04:25:28 +0000

In perusing CSIS’ latest report on Iraq, I noticed The Wisdom of Crowds was used in designing the methodology for measuring reconstruction efforts. Berry interesting…

By: Kieran Healy

Kieran Healy — Thu, 09 Sep 2004 03:43:06 +0000

Here’s a different version of the trend surface href=”http://www.kieranhealy.org/files/misc/dem04.pdf” rel=”nofollow”>http://www.kieranhealy.org/files/misc/dem04.pdf. A bit more discussion here href=”http://www.crookedtimber.org/archives/002466.html” rel=”nofollow”>http://www.crookedtimber.org/archives/002466.html

By: nnyhav

nnyhav — Thu, 09 Sep 2004 02:51:51 +0000

Still, all this going on about the time value of money, and no one’s seen fit to equate it to neglecting the cost of Kerry?

By: Jon H

Jon H — Thu, 09 Sep 2004 02:36:32 +0000

dsquared – if you write this up as a paper, you really ought to redo the graphs. I suggest using little Bush heads and Kerry heads to mark the data points.

By: Jon H

Jon H — Thu, 09 Sep 2004 02:20:51 +0000

Back in the 80’s, there was this thing on Friday nights on MTV, where they’d play two videos and take votes on which was better, via calls on a 99 cent 1-900 number. That strikes me as being just as much a ‘market’ as the Iowa electronic market. The only difference is that MTV never promised a financial payoff. It only offered an emotional payoff in the form of having your favorite video “win”. Yet real money was at stake, in the form of the charge on your phone bill. I think that the Iowa market actually operates in a similar way. I suspect many people who participate aren’t actually doing it to get a financial return, and they aren’t concerned about the fate of their small ‘investment’. They’re just doing the equivalent of voting via a 99 cent 1-900 number.

By: James Surowiecki

James Surowiecki — Thu, 09 Sep 2004 01:59:57 +0000

I should also say, with regards to the moving-average/last-price question, that I think—as I argue in my book—that most of the time the market price in fact reflects the collective judgment of the crowd of investors. (The price of the last trade before market close probably doesn’t, but most of the time the two will be very close.) So I don’t think the distinctions between information markets, financial markets, parimutuel pools, or sophisticated voting systems are really all that important. In the terms Daniel sets out at the end, I think all markets are, roughly speaking, information markets. But Daniel—and most corporate-finance theorists—disagree with me on this, so I’ll be satisfied with the idea that the IEM, at least, is aggregating probabilistic forecasts. The more substantive question has to do with Daniel’s implicit argument that in the absence of an opportunity for real profits, no one will invest any money in these markets. That may be the case, and one way around it is to subsidize them, as Robin Hanson suggests. But I’m unconvinced that the markets need to be real-money markets in order to aggregate useful information. A recent comparative study of the performance of the Newsfutures (which is a play-money market, with prizes for the best performers) and the Tradesports markets in NFL games found that the prices in the two markets were about equally good predictors of outcomes. (They were both, unsurprisingly, very good predictors.) Now, the NFL is perhaps a special case, since there’s lots of public information and there a lot of people who devote a lot of their free time to keeping up with the game. But it suggests that in at least some circumstances—certainly, I think, within many organizations—markets or other aggregating mechanisms can produce valuable forecasts even in the absence of the opportunity for material profits. (I think there do need to be rewards for good performance, but I think these could take a variety of forms.)

By: Alex

Alex — Thu, 09 Sep 2004 00:31:26 +0000

whoopsie thats N(d2) for the binary .. sorry math guys.

By: Phill

Phill — Thu, 09 Sep 2004 00:31:13 +0000

I think you are way off here. The prices of options may reflect supply and demand. The most obvious explanation of the price of the Kerry contract is that large numbers of people realize that the cost of a Bush victory is another four years of utter incompetence. These individuals are therefore taking the rational step of insuring themselves against a Bush victory. The same effect is seen in insurance markets. I buy insurance on my house even though I neither expect nor desire the house to burn down. I pay substantially more for that contract than the probability of a total loss times the insured value.

By: Alex

Alex — Thu, 09 Sep 2004 00:25:32 +0000

“In other words, if the VS market is predicting that Kerry is going to get 49% of the vote, is there a price in the WTA market that should follow from that?” I suspect no such inference could be drawn without using some speculative anticipated volatility of VS (as would be needed for the n(D1) expression in B-S that means the same thing as the binary.)