Economics

Market Reaction to the Election

Posted by Peter on November 19, 2004
Posted in: Economics, Investing, U.S. Politics.

The stock market rose in reaction to Bush’s victory, which wasn’t much of a surprise. What was moderately unusual was that the dollar sank relative to many other currencies and relative to gold, and a steady sinking trend seems to be continuing. In fact, measuring the S&P 500 relative to gold, it went down the day after the election and is a tiny bit lower now than before the election. I doubt that this indicates any belief that Kerry would have been better than the typical Democrat at reducing inflation. It seems to imply that the Bush (or the Republicans in general) have abandoned the fiscal responsibility that we used to associate with Republicans.

The decline of the dollar seems to be overwhelming the Chinese attempts to prop up the dollar to the extent that it is stable relative to the yuan. It seems strange that government officials think they can manage a gradual and widely anticipated change in the exchange rate. If interest rates on dollar-denominated holdings was higher than yuan-denominated holdings, people might expect the two to be equally good investments. But dollar interest rates seem to be a good deal lower, which makes it obvious to anyone who believes the official hints that yuan holdings are a better investment. And there are reports that China has bought increasing amounts of dollars from people who realize this. This suggests to me that a sudden collapse in the dollar relative to the yuan is not too far off when the Chinese government realizes a slow decline is expensive.

Charity Angels

Posted by Peter on November 18, 2004
Posted in: Economics. Tagged: .

Marginal Revolution summarizes an idea of Robin Hanson about how to overcome the problem of poor information regarding who is worthy of what charity (which I agree is a serious problem).

Unfortunately, I doubt it will work, because it suffers from very similar information problems as direct charity does. It requires donors to have good information about what a prototypical worthy recipient looks like (but having this information seems like a large part of the problem we are trying to solve), or else be able to hire someone who has better information about that than the donor (but Robin provides some strong reasons to doubt that is possible in his more recent paper He Who Pays The Piper Must Know The Tune).

I can imagine (but am unconvinced) that donors can describe the appropriate criteria for worthiness, and that the main information problem is distinguishing honest claims of meeting those criteria from dishonest claims. But the charity angels scheme rewards people for failing to distinguish honest claims, which makes me doubt that the giving that this scheme would encourage has much to do with truly worthy causes.

The “Tell Off A Jerk” variant on this theme seems closer to a workable idea, but it risks producing flame wars where people polarize into groups each of which uses charitable donations to encourage retaliation for the other group’s rude attempts at deterring jerkdom.

Accelerating Change Conference

Posted by Peter on November 11, 2004
Posted in: Freedom, Investing, Virtual Worlds. Tagged: , .

The 2004 Accelerating Change Conference focused much more on current changes than last year’s attempts at providing long-term visions led me to expect.

The one topic that excited me was a virtual world called Second Life. While it might sound superficially like just a virtual Burning Man, the designers are serious enough about their nationbuilding to encourage commerce, both within the system and via currency exchanges such as The Gaming Open Market with other worlds. Their VP of Product Development Cory Ondrejka described Hernando de Soto’s book The Mystery of Capital as "must reading". They have been careful to insure that people have few incentives to take disputes arising in the virtual world to meatspace courts. For instance, they once banned a vandal from the game who owned a fair amount of land; they auctioned off the land and sent him a check for most of the proceeds – $1600.

Some of their customers are doing well enough in the virtual world that the company that runs Second Life has trouble offering them a salary good enough to compete with what they’re making in virtual life.

They don’t seem as concerned about the highly deflationary effects of their monetary policy as I expect they ought to be. Why will people buy their land (the sale of which seems to be their main source of income) if they can earn a safe and sure return by just holding the local currency?

The responsiveness of the company to citizen complaints (e.g. simplifying and later abolishing taxes in response to tax revolts) is fairly strong evidence that a non-monopolistic dictator is better than a democracy with monopoly power.

Tradesports compared to the pollsters

Posted by Peter on November 3, 2004
Posted in: Idea Futures, Investing, U.S. Politics. Tagged: , .

Once again, I feel somewhat humbled for underestimating the accuracy of presidential election markets. At least I was cautious enough to mainly bet against Bush winning states where he appeared to be behind, and against him winning 400 electoral votes, which made up for what I lost betting that Kerry would win the election and popular vote.

Assuming the preliminary results are accurately indicating the final results, Tradesports did quite well at predicting the elections (except for a few hours on Tuesday afternoon when it mistakenly reacted to exit polls). It’s Monday evening prices correctly indicated which presidential candidate would win each state. And it did a good job of indicating which states were closest (saying Iowa and Ohio were the least certain).

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Senators and Intelligence

Posted by Peter on November 1, 2004
Posted in: Idea Futures, U.S. Politics. Tagged: .

Voters in Oregon and the Dakotas should remember what their Senators said about the DARPA project to create a futures market designed to provide information about terrorism. Ask yourself whether our presidential election would be decided more intelligently if we had a futures contract that predicted how many people would die in terrorist attacks over the next four year if Bush stays, and a similar one for a Kerry presidency. Many press reports that describe the reactions of Ron Wyden (Oregon), Byron Dorgan (North Dakota), and Tom Daschle (South Dakota) to the DARPA project are available here.

Manipulating futures markets

Posted by Peter on October 29, 2004
Posted in: Idea Futures, Investing, U.S. Politics. Tagged: .

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.

Greenspan and bubbles

Posted by Peter on October 21, 2004
Posted in: Investing. Tagged: .

According to an October 19 Bloomberg article, Greenspan said:

"Housing price bubbles presuppose an ability of market participants
to trade properties as they speculate about the future," and the
expense and difficulty of moving "are significant impediments to
speculative trading and an important restraint on the development of
housing price bubbles,"

I wonder how he would describe the Japanese real estate prices of the late 1980s.
It might not be a coincidence that the dollar has dropped against gold and other currencies the past couple of days.

I’m not yet willing to bet money that a significant housing bubble is developing in the U.S., but it wouldn’t take too much for me to decide it’s time for such a bet.

Efficiency of presidential election futures markets

Posted by Peter on October 17, 2004
Posted in: Idea Futures, Investing.

Tyler Cowen and Mike Linksvayer discuss the somewhat confusing reaction of Bush wins futures to the first debate.

I have some different theories about what might have happened. The size of a typical trade seems to be a few hundred dollars or less, so the typical reward for being quick to exploit inefficient prices is probably in the $10 to $30 range. It’s fairly easy for me to imagine that the most sophisticated traders value their time enough that such rewards don’t cause them to react quickly. I’ve been making a small but steady return from fairly regular trades on Tradesports the past few months, but I only log in about once every two days.

Another possibility is that the best informed traders get their information by talking to undecided voters over several days after the debate.

Either way, as an experienced investor it doesn’t surprise me that markets are slow to react to information that isn’t very clear. Markets often show more frequent patterns of prices following a trend than I would expect from random behavior. I interpret this as evidence that some information gets reflected slowly in those prices. That doesn’t mean it’s possible to get rich by any simple trend following rule – enough of those trends are false signals created by traders trying to exploit the naive trend follower that it’s hard to get useful information out of the trends unless you combine it with good information about what the efficient price should be.

Idea Futures markets obsolete?

Posted by Peter on October 14, 2004
Posted in: Idea Futures. Tagged: .

I attended a fairly interesting talk at PARC last week by Bernardo Huberman. He claimed to have created something that sounds like a hybrid between a survey and an idea futures market.
It involves selecting a small group of people (the minimum for it to work well is about 9 people). It includes some market-like trading between participants, but the results are apparently better than what markets would produce under similar conditions, because it does additional calculations such as adjusting for measured risk aversion of each participant, and has something that treats private information (i.e knowledge available to only one participant) differently from public information. At least some of the time Huberman gives participants monetary incentives to get the right answer.
This approach has an advantage over idea futures markets that bad guys are less likely to be able to manipulate it by spending money to produce inefficient prices, because the organization running the system exercises more control over who participates and how much influence each one has. Not that I think idea futures markets suffer any significant problems due to forms of manipulation like this that require the manipulator to transfer unbounded amounts of money to those who are trying to make the market prices accurate, but the difficulty of analyzing the problem has made such markets susceptible to criticism by demagogues. Also, markets tend to foster some secrecy (as traders want to maintain their advantage), while a more survey-like approach makes people less likely to have a stake in having better information than others, since they’re less likely to be involved in future surveys.
Huberman’s approach does have some disadvantages. It presumably requires the person who wants the accurate information to pay for it (with some associated public goods problems in many cases), whereas idea futures markets can often be financed by small commissions on trades. Also, Huberman’s approach probably fails to select the most informed participants in a number of circumstances, thereby failing to extract information that an open market would be able to extract.
A paper covering the most interesting parts of Huberman’s work is available here.
You might also want to see a related criticism of idea futures markets by Manski at http://www.faculty.econ.northwestern.edu/faculty/manski/prediction_markets.pdf, although that paper doesn’t do a very good job of analyzing whether any alternative is better.