Tuesday, 1 June 2010

Prediction market manipulation

Michael Giberson over at Knowledge Problem notes that it's awfully hard to successfully manipulate a prediction market.
While it is true that a trader can often move the Intrade price relatively cheaply, because the markets often are thin, it is well known that a trader can move the Intrade price. No half-way sophisticated interpreter of Intrade price data would take a sudden sharp move based on a few trades as proof of changing fundamentals, at most it might inspire the viewer to scan for new news. It was only a few hours after the March 17 episode before bloggers were calling “manipulation!“ Are observers going to become less willing to call “manipulation!” in a couple of years? No.

While it is true that a trader can often move the Intrade price relatively cheaply, because the markets often are thin, holding the market to the manipulated target price can get expensive. A manipulator can’t buy the price signal, he just rents it for a while. And the rental rate will tend to rise over time because the mis-pricing will attract informed traders to trade against the manipulator.
That's certainly true, and Hanson's lab experiments with Ryan Oprea and Dave Porter suggest that manipulators increase liquidity and increase the returns to informed traders.

That said, it's awfully hard to tell the difference between an insider moving quickly to profit from knowledge he fears will soon get out and a manipulator. Of course, this kind of case probably doesn't matter much from an overall market efficiency perspective: the informed insider will only spike the prices down if he figures that the information will soon be revealed; otherwise, he'd move much more slowly to build up a position at a decent price. If it's manipulation, it ought to be clear in relatively short order as either information will get out justifying the price move, or failure of such information's emergence would have folks bid the price back up.

If a market faces liquidity constraints, though, and folks aren't allowed to make large deposits, prices can be screwy for an awfully long time. I'd be tempted to think that a manipulator was responsible, except that there's zero feedback from an iPredict price in the temperature trading market to any real world policy outcome; rather, it was more likely a guy with deep pockets and severely mistaken beliefs. I was happy to take his money, but annoyed that so much of my capital there was locked up for so long on relatively low return (though sure bet) contracts; and, it offends my sensibilities when prices aren't in line with fundamentals.

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