Income Inequality

The prediction markets predicted the election outcome more accurately and more quickly than polls or other forecasting methods, just as expected from decades of research. In this election, however, many people discounted the prediction markets because of large trades on Polymarket. Paul Krugman, for example, wrote:

Never mind the prediction markets, which are thin and easily manipulated.

None of that was true but perhaps that was par for the course. Even some prediction market experts, however, began to wobble under the influence of “whale” manipulation theories. But this story was always shaky. What was the supposed logic?

Few directly articulated the theory—perhaps because it sounds absurd when spelled out. The idea seems to be that whales shifted market odds from 50:50 to 40:60, hoping this would drive more people to vote for Trump. Really? Were voters in Pennsylvania watching Polymarket to decide who to vote for? In a decision market, manipulation might be desirable to a whale (albeit unlikely to succeed), but in prediction markets, this scenario seems dubious: a) people would need to know about these markets, b) they’d need to care about probability shifts on these markets (as opposed to voting say the way their family and neighbors were voting), and c) this would have to be an effective way to spend money to influence votes compared to the myriad other ways of influencing voting. Each step seems dubious.

Alternatively, maybe whales were simply wasting money, “memeing” away millions of dollars? Is that something that whales do? The memeing theory is more plausible with many small traders, not a few whales. Or maybe the whales aimed to spark excitement among the minnows, hoping to build momentum before cashing out. However, exciting small traders to inflate prices and then exiting is risky; the same power that whales have to drive up prices can drive prices down just as quickly, making a profitable exit challenging. In short, while not impossible, the idea of whale-driven manipulation in prediction markets was far-fetched.

In fact, we now know that the biggest whale was moving the markets towards accuracy (against his own interest by the way). In an excellent WSJ article we learn:

The mystery trader known as the “Trump whale” is set to reap almost $50 million in profit after running the table on a series of bold bets tied to the presidential election.

Not only did he see Donald Trump winning the presidency, he wagered that Trump would win the popular vote—an outcome that many political observers saw as unlikely. “Théo,” as the trader called himself, also bet that Trump would win the “blue wall” swing states of Pennsylvania, Michigan and Wisconsin.

Now, Théo is set for a huge payday. He made his wagers on Polymarket, a crypto-based betting platform, using four anonymous accounts. Although he has declined to share his identity, he has been communicating with a Wall Street Journal reporter since an article on Oct. 18 drew attention to his bets.

In dozens of emails, Théo said his wager was essentially a bet against the accuracy of polling data. Describing himself as a wealthy Frenchman who had previously worked as a trader for several banks, he told the Journal that he began applying his mathematical know-how to analyze U.S. polls over the summer. 

Here’s the most remarkable bit. Theo commissioned his own polls using a different methodology!

Polls failed to account for the “shy Trump voter effect,” Théo said. Either Trump backers were reluctant to tell pollsters that they supported the former president, or they didn’t want to participate in polls, Théo wrote.

To solve this problem, Théo argued that pollsters should use what are known as neighbor polls that ask respondents which candidates they expect their neighbors to support. The idea is that people might not want to reveal their own preferences, but will indirectly reveal them when asked to guess who their neighbors plan to vote for.

…In an email, he told the Journal that he had commissioned his own surveys to measure the neighbor effect, using a major pollster whom he declined to name. The results, he wrote, “were mind blowing to the favor of Trump!”

Théo declined to share those surveys, saying his agreement with the pollster required him to keep the results private. But he argued that U.S. pollsters should use the neighbor method in future surveys to avoid another embarrassing miss.

Thus, a big win for prediction markets, for Polymarket and for GMU’s Robin Hanson, the father of prediction markets, whose work directly influenced the creation of Polymarket.