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Wednesday, November 07, 2012

Elections happened and Intrade lost

Cat with turquoise eyes by Tambako the Jaguar from flickr (CC-ND)

So elections happened, and Intrade lost big.

There's no need defending them that they still had Obama as leading candidate. Here are some of their minor markets one day ago:
  • Obama to win Florida - 32%
  • Obama to win 320 or more electoral college votes - 26%
  • and so on
Intrade massively overestimate Romney's chances and possible margin of victory and underestimated Obama's.

Meanwhile it seems that Nate Silver got 49.5 out of 50 correct, since he gave Florida exactly 50.0% chances.

Anyway, I'm sure Nate Silver will be getting more congratulations than Obama over the next few days, that's not what I want to write about.

Markets vs Models

My post from two days ago caused a bit of confusion, and perhaps I wasn't entirely clear (but look at the kittens!).

I'm not claiming that yesterday's elections were a definite resolution of markets vs models question. Such resolution is in principle impossible.

Even if Nate Silver gave Obama 99% chances, and Intrade gave him 1%, even that wouldn't really be definite.

First - we have a independent sample size of one. There were multiple predictions made by both Intrade and Nate Silver, but they are not independent at all. By any measure probability of winning Ohio and probability of winning elections were very highly correlated, so we have just one observation.

Second - even if both Intrade and Nate Silver keep predicting subsequent elections, these are not independent events at all! Pollsters, polling aggregators, and market participants will keep changing their methodology based on how their previous predictions worked, so every new prediction is dependent on all previous predictions.

And third and worse of all - we don't even have independent sample size of one. Market participants had full access to Nate Silver's predictions, and could have priced them in, so that's not independent at all.

It's somewhat better in the other direction since Nate Silver claims to have made his model long time ago, and not to have made any tweaks, but then Intrade numbers were widely quoted, and they might have affected both voters and polling organizations, affecting inputs to Nate Silver's model. Compared with other problems this one is probably the least important, but in principle nothing at all is independent!

What was Intrade thinking?

Intrade numbers were so strangely optimistic about Romney it's difficult to take them at face value. Any of these alternatives makes more sense than Intrade traders honestly and rationally expecting Romney to have 30% chance:
  • Deliberate market manipulation on Intrade
  • Completely irrational bubble
  • Traders believing in some kind of vast left-wing conspiracy by pollsters, who all lie about voters' preferences 
  • Traders believing in some kind of vast right-wing conspiracy by voting machine manufacturers or some other kind of massive pro-Romney voting fraud
I'm not joking about these two conspiracy theories - they were both pretty widely discussed all over Internet and apparently some "fair and balanced" cable news stations.

Nate Silver's model actually included some small voting fraud effect of Republican voter suppression efforts, but Intrade traders would have to believe in something much greater than that to reach these numbers.

I think the most likely answer to what happened was some combination of market manipulation and bubble. We know there were attempts to manipulate Intrade by Republicans in both 2012 and 2008 elections.

In theory such efforts should always fail - if there are enough people who care only about making money - and this tends to be a safe assumption on most markets - they'd take advantage of such manipulation attempts and market would go back to rational equilibrium.

However if there's a sufficiently large number of people who take high Intrade prices as solid evidence that actual chances must be high - they can create positive feedback which turns any movement (either random or deliberate) in prices into long term price change.

This sounds speculative, but I have no other explanation for why Intrade's odds of Supreme Court overturning Obamacare increased from 2:1 to 4:1 while nothing whatsoever was happening! Someone pushed prices for whatever reason, people saw that prices are increasing and assumed that this someone has either insider knowledge or some kind of insight, and jumped the bandwagon.

No kind of rational market process can generate both 2:1 odds and 4:1 odds with zero new information.

Now stupid kind of market manipulation - throwing ton of money on the market very quickly - will probably end up being defeated since it's too obvious to everyone. But if you push the market slowly then you might very well generate a lot more positive than negative feedback.
kim by Abdulmajeed Al.mutawee || from flickr (CC-NC-SA)

The case for manipulating prediction markets

That's for some speculation on why market manipulation might work in practice better than in theory, but in leaves a big question - why?

After all even if you successfully manipulated the market, you're very likely to still end up losing money on election day, and most voters don't pay much attention to Intrade.

But there's one route how Intrade odds can plausibly affect the results:
  • Candidate manipulates his odds on Intrade
  • Candidate appears more likely to win to donors, volunteers, journalists and so on
  • Candidate gets a lot more donations and coverage
  • More campaign money and more coverage affect voters
  • Polling shows this
  • And there's positive feedback look
I don't think this would matter too much in presidential elections, but in primaries perceptions of candidates' seriousness is a huge deal. Intrade's preferred candidate Mitt Romney won against everybody else even though he never lead in any polls, and it was clear that he was very far from what the Republican base wanted.

So was Romney campaign or his supporters manipulating Intrade during primaries (and later during elections)? I doubt we'll ever see any hard evidence, but this scenario is broadly consistent with data.

I'll just leave it here as an interesting scenario to think about, not any serious conspiracy theory.

What does it mean for the future?

Actually not that much.

After this loss, Intrade traders in future elections will probably pay a lot more attention to models like Nate Silver's and election fundamentals, and will be much less likely to jump on any bandwagon of either deliberate market manipulation or random bubble.

Unless you're willing to outspend every single market participant put together, successful manipulation is only possible if you can get bubble going, and traders will probably now be much less willing to put too much weight on Intrade prices.

For prediction markets enthusiasts, this isn't even much of a problem in theory - Intrade is very far from a perfect market, with all kinds of transaction costs, and other limitations, so even if Intrade was definitely proven to be biased and bubble-prone (and we have no such proof, just some suggestive data points) - they can keep insisting better prediction market would still be "rational".

Like belief in Efficient Market Hypothesis, belief in rationality of prediction markets is simply immune to data.

Anyway, that's probably the final post about politics, I'll be back to your regular kittens and technology posting soon. (especially once Raspberry Pi I ordered arrives)

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