DanielW's Shortform

DanielW

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If prediction markets are efficient, no one should use them (how they are currently being used). This is something that has bothered me for a while about the claims with prediction markets, particularly when compared to equity markets. Prediction markets are fundamentally a negative sum game (since you lose fees/interest taken by the platforms). If they were efficient (i.e., the price reflects all available information accurately), then you should in general always expect to lose in the long run if you don't have any private information. Equity markets have an obvious advantage of generally being a net positive, since they reflect the value of underlying firms/assets which tend to increase in value.

Of course, the more obvious closer comparison is to financial derivatives. In theory, I do see a strong case for prediction markets as effectively more direct methods of exchanging and managing risk (similar to how financial instruments like interest rate swaps are used). But the reality is pretty much no one using prediction markets trades that way, and indeed people advocating for the use of prediction markets generally discourage using them that way (e.g., a common case made by those like Hanson is that you should bet on things you expect and desire to happen so you have a vested interest in the outcome, this is the exact opposite of what you would do if you were using them as risk management tools, in that case you would want to bet against the outcome you most expect and are making other financial decisions on so that in the case you are wrong the damage is mitigated).

2DanielW7mo

I'll be blunt and start here, as it is an important mistake I see made a lot. I think a lot of people misunderstand what market efficiency refers to. It has nothing to do with individual trader behavior. You could be seeking out the worst investments, that wouldn't matter to the question of how efficient the market is. Market efficiency is just about the price. To the extent the price accurately reflects available information (or the underlying fundamental value) the market is efficient. An individual traders behavior is entirely irrelevant. Also, efficiency doesn't equate to "good" so it can be a bit misleading. You could say roulette is 95% efficient, since the price is just off by ~5% of the underlying value (which can be ascertained by available information). But there isn't any way for you to reliably capture that 5%, it is off because of value captured by the house. And, like prediction markets, roulette is a negative sum game. [...] Sure, hence the "if" in my original comment. If you are doing it because you like to gamble, that's fine. Risk hedging also theoretically makes sense, but isn't currently how the markets are being used in any meaningful aense (and as mentioned runs dirextly contrary to how proponents like Hanson often suggest they should be used). If you think the average traders are predictably irrational it should be possible to take their money and enrich the platform in the process. That seems like a bad thing and a good reason to advocate against prediction markets. Negative sum games are not exactly great for the economy, and anyone with altruistic views should view negative sum games as definitionally net negatives, I would argue. Proponents of prediction markets generally argue they are efficient markets. If they aren't, the utility generally claimed to exist isn't there. [...] Spending money doesn't gain information. As I mentioned in my other comment. There is no additional price discovery function you can access to by placing a b

1papetoast7mo

I think I am implicitly just saying that prediction markets are not perfectly efficient. I think that is normal and still have great utility, I don't think efficient markets are something to be worried about because they will only exist mathematically. All these behaviors that only make sense when the market is not efficient makes sense exactly because the market is not efficient. But, there are different degrees of inefficiency. It is a scale, and I think prediction markets are pretty accurate already even if it is not mathematically efficient. Have you seen the brier score on different prediction markets? They are obviously not perfect, but it is pretty close. Close enough that it sometimes makes sense to act as if market probability = true probability. Also the prediction markets are not negative sum for society as a whole, the fee doesn't just evaporate. It simply goes to the platform. Taking money from dumb people in a zero-sum game is fine. [...] Again I am assuming an imperfect world. There are a lot of public information but you don't want to spend time aggregating them, instead you create a market and put $10k in the automatic market maker to incentivize people to make their best guess.

just saying that prediction markets are not perfectly efficient

I wouldn't say anyone is really discussing perfect efficiency. You could reasonably say roulette is a fairly efficient market, the price accurately reflects 95% of the value.

There isn't really value you can reliably, fairly make off them (otherwise someone like Jane Street would probably have scooped it up). You may be able to make money in some, but odds are more likely than not you are wrong and the juice isn't worth the squeeze.

Close enough that it sometimes makes sense to act as if market p

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