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Exactly right. "The idea is that a true insider will place a large bet that provides valuable information to the market." Yes, and in practice, the true insid

Exactly right. "The idea is that a true insider will place a large bet that provides valuable information to the market." Yes, and in practice, the true insider has every incentive to provide false information to the market, so as to manipulate people's expectations. The insider seeks alpha by trading on the resultant volatility in that prediction's pricing. Let's imagine I am the perfect insider. I have a crystal ball that somehow gives me 100% flawless predictive ability into the outcome of a particular bet (say, the next Republican primary). I could make a fair amount of money by betting on the winner, or I could make a lot more money by manipulating the information in the marketplace, creating volatility in the prices of the prediction bets, capitalizing on each fluctuation, while still holding some inventory in the correct outcome. If I knew the winner was going to be Joe Blow, I could bottom out Joe Blow's price by seeding false information, buy him low, then do the same for other candidates. Of course, the real world doesn't have perfectly predictive crystal balls. But because prediction markets are too small to cause real-world changes (i.e., there's no observer effect), manipulating information would not have a demonstrable effect on outcomes (as it would in a larger, more efficient marketplace). Ergo, as the insider with better info than most, my incentive is to mislead. I do not need a crystal ball to make a killing; I just need slightly better information than the rest of the market. The smaller the market, the more likely it is that my inside information is better than the market's. In a much bigger market, I couldn't get away with this strategy. At least not very easily or reliably. My seeding misinformation about Joe Blow would actually hurt Joe Blow's fundraising ability, thereby creating a self-fulfilling prophecy, thereby causing the market price to more accurately reflect reality. If I massively short Joe Blow, Joe Blow's chances actually drop. I'd get less alpha. But as you've said, the markets are way too closed and small to exhibit such an effect -- so I can rig the game accordingly.

aamar 13y ago
I could make a lot more money by manipulating the information in the marketplace, creating volatility in the prices of the prediction bets, capitalizing on each fluctuation, while still holding some inventory in the correct outcome. And one extreme version of this is mounting a credible campaign then "throwing" the race or withdrawing abruptly. This is attractive whenever the possible winnings in the prediction market are large and the market is insufficiently regulated. In ordinary financial markets, there can be special scrutiny paid to shorts, but the zero-sum game structure of a prediction market loses the distinction.
- jonnathanson 13y ago
  True, although not every trade is zero-sum per se, depending upon the prediction market. More sophisticated trading strategies involve profiting off of the changes in probability of a given outcome over time (or at least the changes in perception of that probability), rather than simply buying and holding a one-sided bet on fixed odds. They amount to psychological manipulation of the market, buying and selling the same positions over time at local minima and maxima. You're absolutely right about the power to "throw" a prediction market, however, provided the right parties can conspire to do so. This is essentially what Arnold Rothstein and associates did in fixing the 1919 World Series. Most people casually assume the fixers bribed the players to throw the game, then profited off the results. In actuality, their strategy was slightly more nuanced. They spread the rumor that the game had been fixed long before they actually fixed the game, thereby forcing an adjustment of odds on (illegal, unregulated) gambling books. This allowed them to hedge long against their predominantly short bet, covering them adequately in the event that the fix was insufficient to adjust the game's most likely outcome.
michaelt 13y ago
Why would you need a crystal ball in order to manipulate the information in the marketplace and capitalise on fluctuations? Surely, as long as you don't hold a position in the market when the results come out, the final results don't impact your profits?
- jonnathanson 13y ago
  The "crystal ball" was my attempt at making an analogy for a situation in which the outcome is held equal. Perhaps it was unnecessary or clumsy as analogies go. Read my post and mentally strike out the crystal ball analogy, and to your point, a lot of what I was saying still holds true.

aamar 13y ago

I could make a lot more money by manipulating the information in the marketplace, creating volatility in the prices of the prediction bets, capitalizing on each fluctuation, while still holding some inventory in the correct outcome. And one extreme version of this is mounting a credible campaign then "throwing" the race or withdrawing abruptly. This is attractive whenever the possible winnings in the prediction market are large and the market is insufficiently regulated. In ordinary financial markets, there can be special scrutiny paid to shorts, but the zero-sum game structure of a prediction market loses the distinction.

jonnathanson 13y ago
True, although not every trade is zero-sum per se, depending upon the prediction market. More sophisticated trading strategies involve profiting off of the changes in probability of a given outcome over time (or at least the changes in perception of that probability), rather than simply buying and holding a one-sided bet on fixed odds. They amount to psychological manipulation of the market, buying and selling the same positions over time at local minima and maxima. You're absolutely right about the power to "throw" a prediction market, however, provided the right parties can conspire to do so. This is essentially what Arnold Rothstein and associates did in fixing the 1919 World Series. Most people casually assume the fixers bribed the players to throw the game, then profited off the results. In actuality, their strategy was slightly more nuanced. They spread the rumor that the game had been fixed long before they actually fixed the game, thereby forcing an adjustment of odds on (illegal, unregulated) gambling books. This allowed them to hedge long against their predominantly short bet, covering them adequately in the event that the fix was insufficient to adjust the game's most likely outcome.

michaelt 13y ago

Why would you need a crystal ball in order to manipulate the information in the marketplace and capitalise on fluctuations? Surely, as long as you don't hold a position in the market when the results come out, the final results don't impact your profits?

jonnathanson 13y ago
The "crystal ball" was my attempt at making an analogy for a situation in which the outcome is held equal. Perhaps it was unnecessary or clumsy as analogies go. Read my post and mentally strike out the crystal ball analogy, and to your point, a lot of what I was saying still holds true.