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.

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4 thoughts on “When will manipulation of public prediction markets begin to work?

  1. Suppose that a manipulation is successful. How would we know ex-post that the market had been manipulated?

  2. A point of reference. A friend who is the CEO of a public (but lightly traded) company suggested that I watch his share price on the end of every quarter at 3:55 PM. Like clockwork, it always sees a 10 – 20% bump on a 100 – 1000 share block trade. He had been turned onto the trick by their investment bankers who noted that it’s a very easy way for fund managers to boost the value of their portfolio for quarterly reporting (but only possible in relatively illiquid securities where that small, late day trade can swing price).

    I mention because the tricks are all well known and discounted by the smart money on the street. So as you say, thinly traded markets will always be manipulated. However, I’d argue that it doesn’t really matter at a macro level.

  3. Mike’s question is good, and difficult to sort out on objective evidence. Here is a scenario:

    Assume the goal of the manipulator is to elect a candidate, the best estimate of the likelihood of a candidate winning is 25 percent, and the original market price in a prediction market is 25. The manipulator believes current support for the candidate is weak, but will grow if it becomes believed that support is strong. The manipulator enters the market, buys contracts that pay off if the candidate wins, which drives the price up sharply. The falling price convinces some uncommitted or opposed voters to join in support, causing the new best estimate of the candidate winning to increase to 75 percent.

    Compare that scenario to a second one: a speculator observes the current market price for the candidate in a prediction market is 25. The speculator believes, “If the price is driven up sharply, then many more supporters will join with the candidate and the prediction market price will rise significantly. Therefore, I can make money buying contracts that pay off if the candidate wins.” So the speculator buys contracts that pay of if the candidate winds, which drives up the price, which brings new supporters to to the candidate, causing the new best estimate to rise to 75.

    The only difference in the stories is in the intention of the trader – either wanting the candidate to win with the prediction market profit a side benefit, or wanting the profit and not caring about the effect on the candidate’s chance of election.

    In the real world, if you knew the trader’s portfolio then you might hazard a distinction. A speculator would likely have many other trades, others of which would likely also be sophisticated. A manipulator might have no other trades, or only trades exhibiting a consistent bias (favoring all candidates for one party, for example). This isn’t public information, and it isn’t dispositive of the question, but the exchange itself could use such information to assess whether or not it is likely manipulation or speculation.

    I suspect speculators and manipulators have different trading patterns, too. Speculators willing to take profit, willing to change their mind about a losing proposition, while manipulators more interested in moving the price on a single contract or related contracts and holding it. Again, not public but accessible to the exchange.

    BTW, even if the exchange could tell the price was being “manipulated,” it isn’t clear that it ought to try to stop it. After all, the thinking is that manipulator’s money tends to subsidize the information-gathering efforts of other traders, and why wouldn’t the exchange be willing to allow that to happen?

  4. “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 agree with most of what you wrote, but there are a few other considerations. In the Health Care Reform market, the manipulation was obvious and occurred during the early morning. It wasn’t corrected until after many morning newscasts had likely been written. Consequently, the manipulation could have had an effect on the news reported about Health Care Reform, which may have helped sway political opinion.

    We saw how easy it was to effect a major manipulation of the market. What if the manipulation had been of a much smaller magnitude? Maybe the manipulation could be small enough that informed traders would not be motivated to correct the market price. Subsequent small manipulations could remain uncorrected. Eventually, corrections might occur, but in the mean time, media reporting of the probabilities might actually influence the outcome.

    In the quote, above, you indicate that it is unlikely that the market price will be trusted more than available information, but I don’t think this will be the case for a variety of markets in which the available information is weak (incomplete). The best example I can think of is global warming metrics. There are not enough participants that have relevant information and the implications of such information are not well understood (or are contradictory). If there is no credible, established method of using the available information to make a prediction, the market price is much more likely to be “trusted” (i.e. there is no “better” prediction available). I think this could apply to a great variety of issues on which the experts are divided and/or each has a very small piece of the pie.

    In these types of markets, manipulations are much more likely and they are also much more unlikely to be corrected. Worse, the manipulations might actually sway political support and influence the actual outcomes.

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