Manipulation of Prediction Markets

by on October 18, 2008 at 7:41 am in Economics | Permalink

As many people suspected someone was manipulating Intrade to boost John McCain’s stock price:

An internal investigation by the popular online market Intrade has revealed that an investor’s purchases prompted “unusual” price swings that boosted the prediction that Sen. John McCain will become president.

Over the past several weeks, the investor has pushed hundreds of thousands of dollars into one of Intrade’s predictive markets for the presidential election, the company said.

This is big news but not for the reasons that most people think.  Although some manipulation is clearly possible in the short run, the manipulation was already suspected due to differences between Intrade and other prediction markets.  As a result,

According to Intrade bulletin boards and market histories, smaller investors swept in to take advantage of what they saw as price discrepancies caused by the market shifts – quickly returning the Obama and McCain futures prices to their previous value.

This resulted in losses for the investor and profits for the small investors who followed the patterns to take maximum advantage.

This supports Robin Hanson’s and Ryan Oprea’s finding that manipulation can improve (!) prediction markets – the reason is that manipulation offers informed investors a free lunch.  In a stock market, for example, when you buy (thinking the price will rise) someone else is selling (presumably thinking the price will fall) so if you do not have inside information you should not expect an above normal profit from your trade.  But a manipulator sells and buys based on reasons other than expectations and so offers other investors a greater than normal return.  The more manipulation, therefore, the greater the expected profit from betting according to rational expectations.

An even more important lesson is that prediction markets have truly arrived when people think they are worth manipulating.  Notice that the manipulator probably doesn’t care about changing the market prediction per se.  Instead, a manipulator willing to bet hundreds of thousands to change the prediction of a McCain win must think that the prediction will actually affect the outcome.  And if people think prediction markets are this important then can decision markets be far behind?

Hat tip to Paul Krugman.

John B. Chilton October 18, 2008 at 8:48 am

Alex: This is very cool.

The next step is to offer an story of how manipulating the prediction could affect the outcome: My conjecture is that raising the specter of a McCain win motivates turnout amongst the Obama supporters, makes McCain voters complacent, and for those voters motivated to vote to temper a liberal Obama mandate by staying at home it pushes them to vote Obama. This, in turn, suggests the politics of the manipulator.

Steven Bass October 18, 2008 at 8:56 am

Sorry, that should read “hedging against a McCain presidency.”

John B. Chilton October 18, 2008 at 9:11 am

Steve: What can I say but “very cool.” For other readers, I repeat the link he gave as a hyperlink,
http://www.intrade.com/news/news_300.html

And some quotes from the Intrade investigation: “The trading that caused the unusual price movements and discrepancies was principally due to a single “institutional” member on Intrade. We [Intrade] have been in contact with the firm on a number of occasions. I have spoken to those involved personally. We are satisfied that they are using our markets in good faith and in the ordinary course of their business and that there has been no contravention of our Exchange Rules. Our investigations lead us to believe that the member is using increased depth in these markets to manage certain risks.”

Grant Gould October 18, 2008 at 9:20 am

Steven: I am astonished that the market had enough volume to allow reasonable hedging of political risk. Surely that’s the definition of success for a prediction market right there!

Of course one would expect that future such hedgers would coordinate their bets across multiple contracts and markets so as to give away slightly less of a free lunch to more careful and information-oriented traders — this looks like a singularly badly constructed bet, and they probably substantially overpaid as a result.

Daniel Clarke October 18, 2008 at 9:50 am

Alex, reread my favourite ever post on the Marginal Revolution page. http://www.marginalrevolution.com/marginalrevolution/2008/01/prediction-mark.html

Punchline: Betting large amounts on ‘the other candidate’ is similar to donating large amounts of money to your candidate if it incentivises people on the other side of the bet to vote (and persuade others to vote) for your candidate. Think of it as campaign contributions without the red tape.

i.e. those bets could (rationally) have been placed by an Obama supporter.

Peter Klein October 18, 2008 at 11:29 am

It shouldn’t be true both that 1) manipulation can improve markets because it allows informed investors to bet against the manipulator, and 2) prediction markets can affect the outcome of elections. If people are influenced by prediction markets in their election choices then presumably they would be equally influenced in their trading. In other words if predicting a certain outcome more likely can move other people to vote in the same way, then it should be equally plausible that manipulating trades in any market can beget other trades in the same direction.

brainwarped October 18, 2008 at 12:06 pm

McCain is trading at 16… You pay $1.60 per contract, if McCain wins, you get $8.40 per contract. And according to the pundits, this election is “close”. So if Intrade is representative of McCains odds to win, then his stock is highly undervalued at 16% chance to win. If I traded, I would definitely buy McCain right now as part of my portfolio.

J October 18, 2008 at 12:49 pm

“This resulted in losses for the investor and profits for the small investors who followed the patterns to take maximum advantage”

Did the investor already get out of this position? If not, they haven’t lost a dime yet, and, as brainwarped points out, stand to profit handsoomely if McCain wins. Disclaimer: I happen to think McCain will win if Obama isn’t at least 9 points ahead in the polls on election day.

J Thomas October 18, 2008 at 1:47 pm

McCain is trading at 16… You pay $1.60 per contract, if McCain wins, you get $8.40 per contract. And according to the pundits, this election is “close”.

Do you believe the pundits? Why would you pay attention to them? Would you trust their stock picks?

http://electoral-vote.com/

If these guys are right about the polling, Obama will win unless he loses everywhere he’s currently less than 5 points ahead, and also at least one state where he’s 6 or more points ahead.

If we figure a state is “close” when nobody’s ahead more than 4 points, there are 8 states like that. McCain would have to take all of them plus at least one more, probably VA MN or CO.

If you believe the polls are honest and the election is honest, then 16% is probably high. But if you agree with J that the elections are rigged to overcome an 8 point lead, then McCain will probably win. How much would you bet that US elections are honest?

(The polls aren’t definitive. Pollsters pay most attention to the close races. Many of the lopsided contests haven’t been polled in october at all. Could solid red states go against McCain due to the economy? Could solid blue states go against Obama for campaigning to give Bush/Paulson a trillion dollars to bail out their friends? The solid states that have october polls mostly haven’t changed. Presumably each blames their villain of choice.)

Rich Berger October 19, 2008 at 6:58 am

This is fishy. When McCain caught Obama in the polls after the convention, the Intrade odds mirrored that move. Now, McCain’s odds have continued to drop even as the polls tighten. I think the manipulation has been running against McCain.

J October 19, 2008 at 8:06 am

“If you believe the polls are honest and the election is honest, then 16% is probably high. But if you agree with J that the elections are rigged to overcome an 8 point lead, then McCain will probably win. How much would you bet that US elections are honest?”

Just to clarify, I don’t think anything is “rigged” here – I think the polls understate support for McCain, a chronic problem when a black democrat runs against a white republican, and in some other situations too. Obama himself pointed out the other day that he lost the NH primary despite being 11 points up in the polls. Actually, his RCP average was 8.3 ahead, though the spread was 10.9: http://www.realclearpolitics.com/epolls/2008/president/nh/new_hampshire_democratic_primary-194.html . A lot of people, particularly democrats, simply will not tell a pollster that they’re voting against a black democrat.

Yes, I expect to see the same phenomenon in the general election.

Greg October 19, 2008 at 11:17 am

The comment about manipulation improving markets seems off to me. Isn’t this just broken windows in the context of a market? It tends to improve profit potential in the market, at the cost of better allocation of capital and short-term price information. It’s a point optimization rather than a system optimization.

J October 19, 2008 at 11:19 pm

“But if we get that result I’m going to apply Occams Razor and proceed on the conclusion it was election fraud”

Given the consistency of the behavior, do you really think fraud is the simplest answer? If you look at past elections, it isn’t that the black democrat’s numbers drop – by much – but that “undecided” voters go overwhelmingly for the white republican. I’d argue it demonstrates that most of those claiming to be undecided really aren’t; I’ve never come across anyone I truly believed was undecided on a political contest in my life (and I’m not a kid).

J Thomas October 20, 2008 at 9:06 am

J, if undecided voters are the issue, Obama can win the electoral college with the states where the opinion polls give him majorities.

To lose he needs people who poll for him to not vote for him.

He would lose if he loses virginia (where he has 51% to 44% in the polls) and also loses ohio, florida, north carolina, and missouri.

Even then he could squeak by if he got any two of nevada, west virginia and north dakota.

I would guess the race issue would be less important in nevada and missouri, both where he has 50% to 46% currently. But that’s only my guess and I haven’t lived in either state.

I guess it’s less devisive to say that McCain will win because of covert racism than to say that he’ll win because of election fraud. Either way we’re heading into trouble.

When I think about it, if you’re right then no matter which one wins it’s a good time to get your family out of the USA. Plus whatever money you have left here.

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Mike Giberson July 16, 2010 at 1:01 pm

Somehow a Huffington Post write links to this post to back a claim: “prediction markets, like the stock market, can be rigged so that they actually affect outcomes.” The word “rigged” is linked to this Marginal Revolution post.

Wait, did McCain win because of an Intrade market manipulation? Did McCain seem more likely to win because of the manipulation? No, the usual prices triggered speculation about mispricings in the markets and informed traders made money.

And contrary to Alex’s claims that the episode suggests “prediction markets have truly arrived”, the degree of price movement reveals the relative lack of depth of the market.

The real link to Hanson’s thinking here is to realize that a truly combinatorial market would implicitly link the McCain contract price to the GOP wins price and the Obama loses price and the Dems lose price, etc., pooling in one place all of the relevant liquidity already being made available to the market but currently kept in little shallow disjoint pools by the Intrade market design.

certnetworks August 11, 2010 at 12:16 am

The real link to Hanson’s thinking here is to realize that a truly combinatorial market would implicitly link the McCain contract price to the GOP wins price and the Obama loses price and the Dems lose price, etc., pooling in one place all of the relevant liquidity already being made available to the market but currently kept in little shallow disjoint pools by the Intrade market design.
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In other words if predicting a certain outcome more likely can move other people to vote in the same way.

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