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.

USA regulates USA — whoops!

Government regulations — numerous ones I might add — are standing in the way of the Treasury plan to recapitalize U.S. banks:

The problem is this: Under existing rules, banks cannot count the
Treasury Department’s investment as part of their core capital, the
foundation of money that supports a bank’s operations. The very goal of
the plan was to buttress those foundations, which have been eroded by
recent losses, undermining the stability of the banks.

The Fed has changed its rule to accommodate Treasury policy and so has the OCC.  But will the Office of Thrift Supervision, the Federal Deposit Insurance Corp. and state banking regulators follow suit?  Sooner or later, yes.  Get this: "All have their own capital standards and it remained unclear early this
afternoon how many of those standards might need to be adjusted."  I vote on the state authorities to come in last.

Jokes about the financial crisis

The most popular game for Icelandic families in 2009?

Go Fish!

What’s the capital of Iceland?

About $20

Iceland was a currency posing as a bank.

I went to an ATM today, and it asked to borrow a twenty till next week.

Quote of the day (from a trader): "This is worse than a divorce. I’ve lost half my net worth and I still have a wife."

In Soviet America, banks rob people because that is where the money is!

Those are from this comments section.  Do you know any such jokes?

Questions that are no longer rarely asked

Why would you leave your money in UBS?

I’m not a close observer of the company, but I have to wonder how they would now describe their business model to a new and eager customer.  Bernard Bauhofer had a funny way of putting it:

The big question is whether high net worth individuals are
willing to stay with an institution incapable of surviving on its
own…

Meanwhile, over at the state-owned bank:      

Clients seeking to open an account last week at ZKB’s
central branch on Bahnhofstrasse in Zurich, a block from UBS’s
headquarters, had to wait as long as an hour. "We don’t know what to do with all the money right now,”
ZKB spokesman Urs Ackermann said.    

My dream

I just had a dream about economics (NB: the word "dream" means that what follows is not real).  It turned out that Fischer Black wrote a short, secret manuscript shortly before his death and that manuscript was just dug up and published in an obscure portfolio journal.  In the piece Black expresses new yet serious reservations about the idea of arbitrage.  He built a simple model in which there are four kinds of arbitrage but each serves as a substitute for investment in human capital.  The more arbitrage an economy engages in, the worse off it is in the long run.  For various second best reasons, most of all related to the concept of superfluous assets and "spanning," the arbitrage did not bring the usual welfare gains from equalizing prices across different markets.

It is rare that my dreams are so detailed or for that matter so analytical.

Joe the Illegal Plumber

I do not think that either candidate will come out against the mandatory licensing of plumbers, but here is the real scoop on Joe:

Thomas Joseph, the business manager of Local 50 of the United
Association of Plumbers, Steamfitters and Service Mechanics, based in
Toledo, said Thursday that Mr. Wurzelbacher had never held a plumber’s
license, which is required in Toledo and several surrounding
municipalities. He also never completed an apprenticeship and does not
belong to the plumber’s union, which has endorsed Mr. Obama. On
Thursday, he acknowledged that he does plumbing work even though he
does not have a license.

Not only that, he calls himself Joe but his real name is Samuel.  He also owes back taxes.  I wonder if he has ever hired illegal immigrants to help him out.  Yes the Republican Party is ******* and I will not vote for them, but how many Democratic politicians will speak out against the coercive restraints placed on Joe (Samuel)?  That’s a serious question.

Addendum: As is often the case, those few of you who are mad at me simply haven’t
read the post carefully enough.  Just for a start, I’m not at all
criticizing the guy for calling himself Joe rather than Samuel.  I was
making fun of those people who are upset by this. Some of you are
committing other misunderstandings as well.  By the way, here are details on Toledo and licensing.

What do you do to stay sane?

Here’s a project asking people to list five things they do to stay sane.  I’m going to arbitrage and ask only for one thing you do to stay sane.  Please leave your answer in the comments.

I try to listen to beautiful music at least once a day, I don’t check my portfolio even in the best of times, I hug a loved one at least one more time than was expected (with adaptive expectations this is hard to sustain over time but I have my tricks), and also I avoid television advertisements as much as possible.  That’s four, you need only offer one.

The Big Necessity

I can’t decide if that is a very good or a very bad title.  Nonetheless the book itself is excellent.  The author, Rose George, stresses:

To be uninterested in the public toilet is to be uninterested in life.

You also learn that toilets may have saved more lives than any other human invention, public toilets are disappearing in London and many other cities, and that many Kenyans have "helicopter toilets," which start with the use of a plastic bag.  My favorite moment in the book is this:

After five hours of my questions, Mr. Tanaka shyly offers two of his own: "Why don’t English people want high-function toilet?  Why is Japan so unique?"

Definitely recommended and yes it is a serious book too.

Kenneth Arrow gets a sentence

There is obviously much more to the full understanding of the current
financial crisis, but the root is this conflict between the genuine social value
of increased variety and spread of risk-bearing securities and the limits
imposed by the growing difficulty of understanding the underlying risks imposed
by growing complexity.

Here is more.  Arrow, of course, has long been interested in issues of complexity and computability, even though his work is within the usual neoclassical confines.  One way of putting the point is that starting a new market creates a negative externality on other people by eroding their knowledge and understanding of context and thus limiting the general ease of economy-wide transparency.  I’m not sure this is true (we usually think of the extra market as adding knowledge), but it is an interesting way to categorize current problems.

The Playmate Indicator

The Environmental Security Hypothesis says that in tough times men will prefer women who are good at production, generally older, taller, heavier, less curvaceous women with less body fat.  In good times, they will prefer women who are good at reproduction, generally younger, shorter, lighter, more curvaceous women.  Pettijohn and and Jungeberg look at the characteristics of playboy playmates from 1960 to 2000 and find:

Consistent with Environmental Security Hypothesis predictions, when social and economic conditions were difficult, older, heavier, taller Playboy Playmates of the Year with larger waists, smaller eyes, larger waist-to-hip ratios, smaller bust-to-waist ratios, and smaller body mass index values were selected. These results suggest that environmental security may influence perceptions and preferences for women with certain body and facial features.

Econometricians who wish to investigate further may download the data here (yes really).  The 2008 Playmate of the year, Jayde Nicole. does not seem to fit the hypothesis however.