Tuesday, October 28, 2008

Crisis = Opportunity

Prediction markets have a big role to play

Historic volatility, unprecedented coordinated bailouts, nationalizations, and bankruptcies of some of the doyennes of the financial elite are just some of the new realities we are all faced with.

Many may well be impressed with the speed and scope of the response to this crisis. I am, but it seems to me that Intrade and all in the prediction market industry have an increased obligation and opportunity to contribute to solutions in avoiding future crises.

Since Enron, WorldCom, Tyco et al and again since this crisis ignited we are being told that maximum transparency, disclosure, and better risk management tools are the answer. These solutions are exactly what prediction markets look to and can deliver.

But is something really transparent if it is buried within a 200 page document or if you need a degree in accounting to decipher it? Likewise, if the costs of producing or gaining access to the information is such that only a few benefit, is that maximum transparency and disclosure?

The Sarbanes-Oxley Act (SOX) introduced after the Enron / WorldCom debacles is considered a success by most. However, in light of recent events and comments from Henry Paulson, John Thain and even former AIG chief Hank Greenberg, who all believe SOX threatens the US competitive position in the global marketplace, it hardly seems a panacea.

This is where prediction markets can really help now and in the future. We offer real-time aggregated collective intelligence that is easy to access and interpret. E.g. recession, tax rates, unemployment, offshore drilling, OPEC actions, bank failures, etc. Prediction markets provide a single number -- the probability or risk of something happening. Right now there seems to be a 75% probability that the US will be in recession in 2009.

To get the best predictive information barriers to entry for participants and providers must fall so that adoption and diversity can grow. To contribute their maximum to society (which we expect will befit Intrade and other leaders in our industry) prediction markets need to be embraced, encouraged, and considered part of a solution to managing risks and change. Only when this happens will there be such diversity and adoption that the markets can reach their full potential in aggregating information on the most important issues.

In addition to new and revised regulations, the time is right for expanded coverage of those regulations to include prediction markets and the innovative solutions they offer. If ever there was a time to embrace innovative solutions for assessing and managing risk it seems that time came before I started to write this short note.

Prediction markets are far from perfect, but they typically deliver incentivized real-time, efficient, aggregated probability estimates on uncertain future risks and events. They have never had a more important role and potential than right now.

I welcome your comments.

John Delaney, CEO, Intrade.



Intrade said...

fannigntheflames said :


I am from the York Management School (University of York, UK) and have started a PhD in the area of prediction markets. I am a teaching fellow, not a 21 year old just out of undergraduate school, who teaches public sector strategy on the York MPA. This is almost my exact area of interest, perhaps we could talk?

Jon(athan) Fanning

Intrade said...

fanningtheflames said :

    Forgot to mention I also part teach the final year undergraduate module in CSR and Governance.

Intrade said...

JOhn Delaney said :


I look forward to your email. My address is above.


Intrade said...

Damon said :

    Hi John, if you don't mind, perhaps you could go into more detail about the problems of prediction markets.

One problem I see with Intrade markets is that it requires one to cover 100% of the max loss for each contract while neglecting to mention that many contracts are negatively correlated.

One example of this is is in the presidential markets where one can hit the bid on all the candidates and collect over 100 (an arbitrage) in theory but in practice requires you to cover the max loss for each. Even with the two frontrunners, Obama and McCain, many times one sees that the sum of the bids is over 100. Without a market maker, these markets get out of whack too frequently.

The consequence of this is that the contracts tend to overvalue underdogs and undervalue favorites because it's easier to add volume if your cash requirements are less.

Intrade said...

Hi Damon,

You suggest that “with Intrade markets is that it requires one to cover 100% of the max loss for each contract while neglecting to mention that many contracts are negatively correlated.”

This is actually not the case for most long term markets with a significant time to maturity but is the case for many short term markets. Let me know if you want us to email examples to you.

With many long-term markets within a group the contracts are linked when they are mutually dependent on one another e.g. there can only be one winner of an event.


Global temperature in 2009 compared to 2008
Is higher
Is lower
Is the same

Only one of these outcomes will occur. Therefore the Exchange links the 3 contracts and freeze funds on the worst possible outcome across all 3 contracts for the positions/orders you have.

Hope this helps,


Intrade said...

Steve said :

    Intrade is a fascinating and exceedingly useful resource. It would be even better if you could replace Kudlow's tiresome, ill-considered commentary with someone with more incisive thinking.

Intrade said...

Nancy Brumback said :

    re: transparency, for we who use intrade to check the perceived probability of events, it would help very much if we knew the size of the betting pool... thanks

Intrade said...

Fearful Taxes said :

    Don't blame me, I voted for the white guy.

Intrade said...

Damon said :

    If the "white guy" was George W. Bush, I CERTAINLY WILL blame you!