Alex Tabarrok writes about the apparent attempts to manipulate the Bush re-elected contract at Tradesports.com (which just dropped to exactly 50!), and CNBC has mentioned the same report today (with a denial from George Soros that he is responsible).
I want to warn people not to treat the failure of this manipulation as strong evidence that manipulation won’t have much effect on the reliability of the prices. If an experienced trader such as Soros tried to engage in this kind of manipulation, he would use a much more patient and cost-effective strategy than quickly driving the price down from 55 to 10.
To estimate the harm done by manipulation, we need to look at careful studies of how accurate markets have been, plus experiments such as the one Robin Hanson arranged. Note also that Robin’s attempt at a theoretical argument on this subject is unconvincing because it unrealistically assumes that traders aren’t risk-averse.
I assume traders are risk-averse because I am explicitly focused on thin information markets, where the amount traded is much less than any trader’s wealth. In this context, people should be pretty close to risk averse.
Kahneman and Tversky have made some fairly strong arguments that people don’t act as you think they should (look for the phrase "loss aversion"). And David Friedman has some hints in Economics and Evolutionary Psychology about why that isn’t an accident and won’t be easy to change – the status quo is a Schelling point with enough advantages in one-on-one interactions that it has been to our advantage over much of our evolutionary history to have an unreasoning commitment to preserving it.
One additional point that I forgot to make in my original post is that Tradesports isn’t designed to minimize manipulation. They require that I have enough cash on deposit to pay for all orders I submit. This reduces my willingness to place orders that have a small chance of being executed.
Our lab experiments count as evidence that people do act as we think they do. These have so far confirmed our theory.