Manipulation of Prediction Markets
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.