Only if there is some actual predictive skill out there to begin with. For example, the article gives the example of a prediction market on coin flips: the winning strategy is to take any bet for less than $1 (assuming that the payoff on a successful prediction is $2). But in short order, everyone who does not play that strategy will go bankrupt, and then there will be no more betting, because everyone remaining in the market will only take a bet at less than $1, but nobody will be willing to offer one. In other words, if there is an obvious limit to how well something can be predicted, the market will reach that point and then stop--no further betting will happen.
Not true at all! A golden example is Betfair's 'exchange games' markets, where they let players bet on fair, computer-managed card games. The markets are always exactly prcied-up. Some punters are playing, but even without the 'mugs' you can just look at the order book to see the predictions.
For the coin flip, you'd still have people asking for odds of 50.1% and others offering odds of 49.9% - you then can just look at the spread to discover the market prediction.
Isn't this in agreement with what I said? I didn't say that the market prices would not reflect the expected predictions. I said that once that happens the market will stop moving, which appears to be exactly what you're saying:
you can just look at the order book to see the predictions.
In other words, there is a limit to how accurately people can predict the outcomes of these card games, and that limited predictive accuracy is what the market reflects. The real question is, how much betting volume is there for a given, fixed card game, once all the players in the market learn the odds? My expectation is that volume will decrease over time for a given, fixed card game, because if the game is fair, the betting is zero-sum, so players who know the optimal strategy will never bet among themselves (since you can't make money on average at zero-sum bets), and players who don't know the optimal strategy will go bankrupt.
Obviously if you introduce a new card game, the above doesn't apply; that would be the equivalent of adding, say, six-sided dice to the coin flip betting site: now there's a new set of odds to be learned, so there will be a new period of trading as market players learn the optimal strategy for this new game.
For the coin flip, you'd still have people asking for odds of 50.1% and others offering odds of 49.9%
Would any actual bets happen at these odds? What makes you think so? An occasional new player might try this, but he would end up losing money, and all the long-term players know that would happen, so they won't try it. Why would they?
Or do you just mean that people would be posting these asks/offers, but nobody would be accepting them? If so, then, once again, this is in agreement with what I was saying; no actual activity would be taking place in the market, but the asks/offers would accurately reflect the market's best available prediction--which is the best possible prediction, hence no money can be made in the market because trades are zero-sum.
I was writing to highlight your seeming disagreement with the text you quoted:
the predictions tend to get better
You seemed to be saying that this was not the case, citing a coin flip. My counter argument is that a real-world prediction market for (effectively) a coin flip tends towards a 'perfect' prediction. It can then stay in this steady-state regardless of whether or not any fool continues to bet; you just have to glance at the order book of unmatched bets to discern the prediction.
So, the predictions do tend to get better, even if you have unskilled participants. Or are you saying "predictions only get better if people are good at predicting", which would be stating the bleeding obvious, right?
(Disappointingly, Betfair's exchange games still seem to have money traded on them, and they run these games every minute of the day.)
I wasn't saying the predictions never change; I was saying that they will only change as long as there is knowledge about the outcome that has not yet been priced into the market. The market "not changing" does not mean it does not have a market price: it just means that the market price is constant (and that therefore there is no trading happening, except for the occasional new player entering and quickly losing money by playing a non-optimal strategy). You are saying the same thing, just in different words.
the predictions do tend to get better, even if you have unskilled participants
This statement as it stands is way too strong, which is why I originally objected. The correct statement is: "predictions will tend to get better as long as it is possible for the average skill level of the market participants to increase". You're right that participants don't have to start out being skilled; but the average skill level of the participants does have to be able to change for the market's predictions to change.
In the coin flip prediction market, that can't happen (or at least it can't happen for very long), because the optimal strategy for betting on coin flips is so obvious. In the Betfair card games, there is some scope for increasing participant skill, but there can't be very much if the games are fair; people will fairly quickly figure out the optimal strategy for any given game, and soon after that the market will stop trading if the players are rational. (You appear to agree with this, since you say it's "disappointing" that Betfair's games continue to have money traded on them.)
Of course these are simple examples; what about real-world prediction markets? What about, for example, betting on sports games? My sense is that a similar effect occurs there: the average skill level of the long-term market participants is relatively unchanged over time, and therefore the accuracy of the predictions that can be extracted from the order book is relatively constant over time. The reason money is still made in these markets is that there is a basically inexhaustible supply of new players who think they know more than they actually do, and who therefore quickly end up losing their money to the long-term players--much the same thing that happens in casinos.
Only if there is some actual predictive skill out there to begin with. For example, the article gives the example of a prediction market on coin flips: the winning strategy is to take any bet for less than $1 (assuming that the payoff on a successful prediction is $2). But in short order, everyone who does not play that strategy will go bankrupt, and then there will be no more betting, because everyone remaining in the market will only take a bet at less than $1, but nobody will be willing to offer one. In other words, if there is an obvious limit to how well something can be predicted, the market will reach that point and then stop--no further betting will happen.