2) Betfair had US election markets with hundreds of thousands of dollars at stake, and this is a site that blocks US users. So the interest and the money is there. (The legal/political problems in many countries are still a big hurdle though) Admittedly, the volumes are still peanuts compared to most sports markets...

3) Not really true. You win a bet if you get the result right, e.g. You predict the result of an event. You don't win by guessing the beliefs of others. Sure, you can trade in and out of a market as opinion changes, but you are still betting on a result and not an opinion.

This isn't really true, at least not for most real prediction markets, because bets can be traded. The article gives an example: the author bought bets on McCain for the 2008 election early on when they were cheap, then sold them shortly before the Republican convention when they were fetching much higher prices. In other words, he wasn't really betting on McCain winning; he was betting on enough people believing McCain had good odds of winning that he could sell his McCain bets at a profit--i.e., he was indeed winning by guessing the beliefs of others.

Secondly, just because he traded, doesn't mean he was solely betting on the beliefs of others. Odds can change over time because of betting activity caused by events, news and information. e.g. news stories, statements, etc. If those changes mean that the OP could trade out, good for him.

Another example: Let's say NASA spots a huge asteriod in space, zooming towards earth. To pass the time, people are betting on whether or not it hits. (Let's not worry about how the bets get paid out!) Common consensus is that there is a 10% chance of a collision, but using your awesome physics knowledge, you reckon there's actually a 30% chance, give-or-take. So, you bet ON the asteroid hitting.

A few days later, a news release from an esteemed astronomer reports that her calculations show that the asteroid is more likely to collide than previously thought. As a result, betting activity on the exchange adjusts and the consensus moves to 28%. Now, you might well be tempted to trade out of your bet at this point, and "lock in" a profit. After all, the odds are close to your own beliefs.

Did you trade because of guessing the beliefs of others? No. You traded because the odds changed as a result of information changes, new info becoming public knowledge. You thought the original bet was value, and you traded out at zero cost to get certainty.

The example of the McCain bets for the 2008 election is a case in point: if the author's bet would only have paid off on the actual outcome, he would have lost! The only reason he was able to make money at all was that he found other people willing to buy his bets.

Similarly, in your asteroid example, yes, you sold your bets because information changed, but the reason you were able to make money doing so was that there were other people willing to buy your bets--which means their expectations about the outcome must have been different from yours (if they were the same as yours, no one would buy your bet, because the trade is zero sum). So you are making money based on others' beliefs about the outcome, not based on the actual outcome.

For example, if the asteroid ultimately does not hit, then all your "yes" bets are losing bets; the only reason you made money was that you sold your bets before the fact that they were losing bets became known for certain, just like the article's author did with his McCain bets. But also, even if the asteroid ultimately does hit, your payoff doesn't depend on that, because you sold your bets; someone else, who bought them, ended up making the profit you could have made if you had held them until the outcome was known. So once again, you made your money based on other people's beliefs about the outcome, not based on the actual outcome. (You even agree with this, when you say that you sell when the market odds are close to your own beliefs: the market odds are determined by the average beliefs of all the participants, not by the actual outcome.)

You can read the raw data, less ambiguous than the text, below the main article.

You're right, and I hadn't grasped that from the article. See my response to the article's author upthread.

Actually, I was. I was betting that either I would hold the shares to completion and receive a full payout or enough information would emerge that McCain's odds of winning were higher than then estimated.

> The example of the McCain bets for the 2008 election is a case in point: if the author's bet would only have paid off on the actual outcome, he would have lost!

And you misunderstood the transactions in question. They weren't whether McCain would win the 2008 election, they were whether he would win the nomination. By the time I sold them, he had locked up dozens more delegates than necessary to guarantee his nomination, and my reason for selling was as stated: the contract was basically settled, I just wanted to avoid him keeling over and costing me my well-earned gains. As it happened, McCain did not die or quit, and so the contract paid out in full. I had been completely right, and was appropriately rewarded.

You're right, I hadn't grasped this from reading the article. However, a key point I made still stands:

my reason for selling was as stated: the contract was basically settled, I just wanted to avoid him keeling over and costing me my well-earned gains.

And the reason you were able to do this is that there were people willing to buy your bets; in other words, that there were people who evaluated the risk of him keeling over differently than you did. If there weren't any such people, you would have had to bear that risk yourself.

In other words, the actual bet in question was not whether McCain would "win" the nomination; that had already been settled--he had enough delegates to guarantee that outcome (and the prediction market could just as easily have been based on the bet "will McCain lock up enough delegates to guarantee the nomination"). The bet was whether he would actually become the nominee, i.e., would actually go through the formal procedure that made him the official candidate; that was the outcome that triggered the payoff, and you did not get paid based on that actual outcome; you got paid based on other people's estimate of the probability of that outcome being different from yours. You were only able to sell your bets because your estimate of the probability of that outcome was different than that of the people who bought your bets, based on your higher estimate of the risk of him keeling over; if everyone in the market had estimated the risk of him keeling over as being higher than your estimate, no one would have bought your bets at any price you were willing to sell them for.

In other words: you did not "win" the actual bet in question, because you did not hold your bet until the actual outcome was triggered--if you had, you would have won more money than you actually received. If you had correctly predicted that he would not keel over before formally becoming the nominee, you could have gotten that extra money yourself. Of course I understand why you didn't do that: you were willing to give up a few cents on the dollar as a hedge against risk. But that doesn't change the fact that you did do it, and therefore you did not win by making a correct prediction about the actual outcome.

(And actually no, it doesn't have to be differing estimates. It could also be risk aversion, liquidity constraints, noise, or a bunch of other things.)

Because people were buying the shares: supply and demand. And of course they were buying them because the general opinion on McCain's chances was changing. I'm not disputing that.

Because I correctly forecast everything important about the bet: that McCain had a much higher chance of winning the nomination than everyone else did, and the market was wrong.

Yes: you basically did the same thing investors do when they believe a stock is undervalued. I'm not disputing that either.

Why does it matter that at some point I closed out my contract?

Because you were able to close it out for any reason at all other than the actual outcome on which the bet was based. The claim to which I originally responded in this subthread (which wasn't made by you, btw) was this: "You win a bet if you get the result right, e.g. You predict the result of an event. You don't win by guessing the beliefs of others. Sure, you can trade in and out of a market as opinion changes, but you are still betting on a result and not an opinion."

Strictly speaking, this is only true if bets (or shares, or whatever you want to call them) cannot be traded. If bets can be traded, then other possible strategies open up that are not possible if bets cannot be traded. You played one such strategy: you correctly predicted that a certain bet (on McCain winning the nomination) was undervalued, so you bought it and waited for the price to go up. When the price had risen enough that the extra gain from continuing to hold the bet was less, to you, than the risk of him keeling over (i.e., less than the benefit to you of risk aversion), you sold your bet.

Such a strategy is not possible if bets cannot be traded. Suppose trading of bets had not been allowed in your case; you would have had to make your original bet knowing that you could not sell it, but would have to hold it until the actual outcome--i.e., you would not have the opportunity to lay off the risk. That would have changed the expected benefit to you from the transaction. (Whether it would have made a difference in what you actually did, I can't say; but it certainly would have changed at least some of the factors on which you based your decision.)

It is quite true that you chose to play this strategy based on your (correct) prediction about the outcome, that McCain would get the nomination. But that doesn't change the fact that the strategy itself, the one you actually played, depended on their being other players in the market to whom you could sell the bet when your desire for risk aversion became large enough. In other words, it depended on trading of bets being allowed, and on other players having different valuations of the shares than you did, so that you could find someone to trade with. So even if you "won" in the sense of correctly predicting the outcome, and realizing a payoff based on that prediction, the opinions of other players in the market still made a difference. That's what I was trying to emphasize.

it doesn't have to be differing estimates. It could also be risk aversion, liquidity constraints, noise, or a bunch of other things.

Technically, yes, there are two general kinds of reasons: differing estimates, and differing values. But in practice they basically amount to the same thing: your expected benefit from various possible courses of action is different from someone else's. That's the key thing that makes things like trading bets possible at all (that and whether or not the particular market in question allows trading bets to begin with).

"The idea is that a true insider will place a large bet that provides valuable information to the market."

Yes, and in practice, the true insider has every incentive to provide false information to the market, so as to manipulate people's expectations. The insider seeks alpha by trading on the resultant volatility in that prediction's pricing.

Let's imagine I am the perfect insider. I have a crystal ball that somehow gives me 100% flawless predictive ability into the outcome of a particular bet (say, the next Republican primary). I could make a fair amount of money by betting on the winner, or I could make a lot more money by manipulating the information in the marketplace, creating volatility in the prices of the prediction bets, capitalizing on each fluctuation, while still holding some inventory in the correct outcome. If I knew the winner was going to be Joe Blow, I could bottom out Joe Blow's price by seeding false information, buy him low, then do the same for other candidates.

Of course, the real world doesn't have perfectly predictive crystal balls. But because prediction markets are too small to cause real-world changes (i.e., there's no observer effect), manipulating information would not have a demonstrable effect on outcomes (as it would in a larger, more efficient marketplace). Ergo, as the insider with better info than most, my incentive is to mislead. I do not need a crystal ball to make a killing; I just need slightly better information than the rest of the market. The smaller the market, the more likely it is that my inside information is better than the market's.

In a much bigger market, I couldn't get away with this strategy. At least not very easily or reliably. My seeding misinformation about Joe Blow would actually hurt Joe Blow's fundraising ability, thereby creating a self-fulfilling prophecy, thereby causing the market price to more accurately reflect reality. If I massively short Joe Blow, Joe Blow's chances actually drop. I'd get less alpha. But as you've said, the markets are way too closed and small to exhibit such an effect -- so I can rig the game accordingly.

And one extreme version of this is mounting a credible campaign then "throwing" the race or withdrawing abruptly. This is attractive whenever the possible winnings in the prediction market are large and the market is insufficiently regulated. In ordinary financial markets, there can be special scrutiny paid to shorts, but the zero-sum game structure of a prediction market loses the distinction.

You're absolutely right about the power to "throw" a prediction market, however, provided the right parties can conspire to do so. This is essentially what Arnold Rothstein and associates did in fixing the 1919 World Series. Most people casually assume the fixers bribed the players to throw the game, then profited off the results. In actuality, their strategy was slightly more nuanced. They spread the rumor that the game had been fixed long before they actually fixed the game, thereby forcing an adjustment of odds on (illegal, unregulated) gambling books. This allowed them to hedge long against their predominantly short bet, covering them adequately in the event that the fix was insufficient to adjust the game's most likely outcome.

Surely, as long as you don't hold a position in the market when the results come out, the final results don't impact your profits?

Read my post and mentally strike out the crystal ball analogy, and to your point, a lot of what I was saying still holds true.

My experience has been they are far, far more accurate than the media. It is the nature of the accuracy that is interesting, however. They come to decisions well in advance of the media -- weeks or even months early. A good example would be this last national election cycle, the prediction markets had Rick Perry and Michelle Bachman virtually closed out while their media coverage was still treating them as viable candidates.

They aren't always right in the long run, but they converge on the right answers much sooner than anything else I've seen, Nate Silver's efforts included.

The biggest problem is that in the US they are either illegal (deemed to be gambling) or just too small (IEM).

True. Little enough good it did the Romney whale on election day, though: he handed $4m as a gift to all the other Intrade users, and it didn't move the needle anywhere.

(1) This is not a "fundamental problem." Not every participant in the NYSE is a savvy investor, either.

(2) This was also true of the automobile market. It didn't stop Henry Ford. This is a serious incidental problem, but not a fundamental one.

(3) The best way to make money in a prediction market is to be able to predict the outcome of the predictions. You can also try to do what you're suggesting, and may have some success. Anyway, the evidence is that prediction markets work, both for hedging and for knowledge prediction.

I don't think this says quite what you meant. :-) As it stands, it can be read as saying that you can make money by predicting what other people believe, which is in agreement with the parent's #3. (And which is also true--as I noted just upthread, the author of the article in the OP did exactly that by buying and then selling McCain bets for the 2008 election.)

The outcome of the predictions is that all the correct predictions resolve to 1 (or 100% or what have you) and all the incorrect predictions resolve to 0.

Technically, I said what I wanted to say. Technical correctness is the best kind of correctness. ;)