When will manipulation of public prediction markets begin to work?

Michael Giberson

At Constructive Economics, Abe Othman discusses a purported manipulation attempt in Intrade’s Health Care Reform bill market.  The nut of the story is that early on March 17th a trader apparently poured a bit of money into the market, briefly driving the price from around 60 down to 35.  After a few hours the price bounced back into the 60s; if it was manipulation, it failed.  But Othman speculates about a future in which manipulation would work.

Because the Intrade price can be interpreted as an estimate of the likelihood that the bill will pass, a sharp fall in the price could indicate new information reaching the market suggesting the bill will fail.  In the manipulation story presented by Othman, a new perception the bill is failing could be used to pressure the weakest members of the coalition supporting the bill to drop out (Maybe the argument goes, “Why go down with a sinking ship, when you and your constituents never wanted the ship in the first place?”).  As support actually falls, the likelihood the bill passes drops with it.  The manipulated price becomes, with a little lobbying, a correct prediction.

While Othman recognizes that the purported manipulation failed this time, he wonders whether prediction market prices will become sufficiently trusted that such a manipulation will work.  In fact, he predicts, “It’s only a matter of time, a couple years I would guess, before the kind of manipulation I’ve described actually works.

I disagree.

While it is true that a trader can often move the Intrade price relatively cheaply, because the markets often are thin, it is well known that a trader can move the Intrade price.  No half-way sophisticated interpreter of Intrade price data would take a sudden sharp move based on a few trades as proof of changing fundamentals, at most it might inspire the viewer to scan for new news.  It was only a few hours after the March 17 episode before bloggers were calling “manipulation!”  Are observers going to become less willing to call “manipulation!” in a couple of years? No.

While it is true that a trader can often move the Intrade price relatively cheaply, because the markets often are thin, holding the market to the manipulated target price can get expensive.  A manipulator can’t buy the price signal, he just rents it for a while.  And the rental rate will tend to rise over time because the mis-pricing will attract informed traders to trade against the manipulator.

Maybe this gets interesting.  So long as the markets are thinly traded then the market signal can be rented cheaply, but observers treat the signal as cheap talk.  What if talk is not cheap?  Can a deep pockets manipulator actually buy the market price?  That is to say, can the manipulator rent the signal long enough to overcome the “cheap talk” dismissal and change the likelihood of the outcome? I’d say this would work only in a world in which enough market observers  trust the market price summary more than all of the other information available about the subject of the prediction market, but this is unlikely to be the world we live in.

I predict: this kind of manipulation will not happen within the next several years.