Book review: Information Markets: A New Way of Making Decisions, edited by Robert Hahn and Paul Tetlock
This book contains some good discussions of current issues in the design of prediction markets (aka idea futures).
Since it’s the result of a conference for experts, it is mainly directed toward experts. It shouldn’t be overly hard for laymen to understand, but it probably focuses on issues that are somewhat different from what most laymen would find interesting, so I’d probably recommend reading Surowiecki’s Wisdom of Crowds or some of Robin Hanson’s earlier papers on the subject first.
One surprising result reported here is that the Iowa Electronic Markets show no longshot bias, in contrast to similar markets on Tradesports/Intrade and to widespread types of sports betting. This looks like an important area for research, although that would probably require setting up many variations on those markets (varying things such as the user interface, commissions on trades, limits on how much money can be invested, etc.), which would be expensive and hindered by regulatory uncertainty.
Michael Abramowicz presents an interesting proposal to create incentives to counteract the likely tendency of markets such as prediction markets to discourage people from making public the knowledge that goes into making market prices efficient. I don’t have much of a guess about how well his solution will work. It needs some more thought about how vulnerable it is to manipulation of the intermediate prices used to reward traders who convince others to follow their reasoning (averaging prices over a week or two would be a simple start at deterring manipulation). But I think he understates the importance of the problems he’s trying to solve. He says “while they are endemic to all securities markets, they apparently cause little harm. They are likely to be much more severe, however, in markets with very few active participants.”. I suspect they are significant in most securities markets, and are underestimated because they are very hard to measure. As someone who trades stocks for a living, I’d say that the amount and quality of knowledge that is shared among traders is quite low compared to most professions, although it’s hard to say how much of this is due to desire to keep valuable information secret and how much is due to the difficulty of distinguishing valuable information from misleading information.