Online magazine Slate has published the Tim Hartford column on possible manipulation of the “H. Clinton becomes President in 2008” prediction market at Intrade. (Yes, the same column that appeared June 29 at the Financial Times , and blogged about here on July 1.)
On this topic, Slate is late and even the FT was a little behind the story. When the FT published last week, the price of the Clinton contract had already fallen most of the way back to the levels that prevailed before the alleged manipulation, and today the price was all the way back to the mid $20s. (If you want to keep up with prediction market news, you need to follow Midas Oracle.)
It is difficult to prove manipulation in almost any market, and manipulation of prediction markets may be much harder to demonstrate that most cases. To try to get a handle on the somewhat slippery notion of manipulation, consider as an example the standards for proving market manipulation under the U.S. Commodities Exchange Act. As summarized in a recent Senate subcommittee report, four elements are required:
(1) the accused had the ability to influence market prices;
(2) the accused specifically intended to influence market prices;
(3) artificial prices existed; and
(4) the accused caused the artificial prices.
In a continuous double auction, such as Intrade, it isn’t too hard to “influence market prices” in the short run – all you need is enough backing to buy or sell your way through the queue of standing orders until you reach your desired price. To maintain your price, you just need pockets deep enough to satisfy all comers. An examination of one’s trading patterns may be sufficient to show ability to influence price and may provide indirect evidence of intention to influence price.
But what about this notion of “artificial prices”? In a general sense, an “artificial price” seems to be a price deviating from fundamentals in ways not readily explained. Perhaps this sort of issue is easy enough to examine for a commodity futures market, but it seems to be much harder to investigate the issue in the case of prediction markets. In particular, how would a market observer – even one with full access to trading records – differentiate between the activities of a deep-pocketed trader who seeks to manipulate the price and a deep-pocketed trader who simply has a significantly different estimate of the underlying probabilities?
I think the potential for manipulation troubles some prediction market folks because it puts an implied asterisk next to any prediction market price that says “caution: the price you currently observe in this market may not truly represent the collective opinion of the population of traders, but instead may reflect an attempt to manipulate the market outcome.” The possibility of manipulation taints the purity of the price as a predictor.
Nonetheless, in the longer run deep-pocketed manipulators are the prediction market’s friend. As a paper by Robin Hanson and Ryan Oprea notes (cited in Hartford’s column), the net effect of a manipulator is to subsidize participation of informed traders in the market and to motivate informed traders to collect more information. More trading, more informed participation, and more information being brought to market: all good things for the market.
(HT Midas Oracle, of course.)