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The Irrationality of the Newsfutures Crowd

For a few years now, I’ve been playing a game called Newsfutures, in which people can “invest” pretend money (X dollars) to buy “shares” of a prediction. The prediction is that some event (the stock market going up that day, some sports team winning a game, the Pope croaking, and so on) will come to pass, and the cost of a share is always between 1 and 99 “X dollars.” The actual price for a share of any event is set in a market, based on what people are willing to sell a share for, and what people are willing to buy a share for. If the event comes to pass, every share becomes worth 100 “X dollars,” making pretend money for those who bet in the event’s occurence. But if the event failes to come to pass, the shares become utterly worthless, losing people all the pretend money they invested in the event. And so the game proceeds as people try to scoop up more pretend money… and keep from losing it.

I consider Newsfutures to be a fun way to get a little gambling in on the side without actually risking any money whatsoever. But some are trying to elevate the Meaning Of It All to some grand level. Take the quote from James Surowiecki, author of The Wisdom of Crowds, that appears at the top of every Newsfutures page:

In a sense, the Newsfutures traders are only trying to do what op-ed writers, TV pundits, and Presidential advisers attempt to do every day: predict the future. The big difference is that the markets are far more likely to be right.

Individually, we’re fallible, but in the aggregate we are wise: this is really just a highfalutin, quasi-academic way of saying “Millions of People Can’t Be Wrong!” But we all know that, yes, millions of people can be and all too often are horribly wrong. Millions of people lined up behind the extermination of the Jews in World War II. Millions of people thought Y2K was going to lead to the end of Western civilization. Millions of people thought that radium watches, X rays for shoe sizing and lead paint for our houses were really nifty. Crowds can be just as foolish, if not more foolish, than individual people.

I found an empirical instance of this last night on Newsfutures. I noticed the presence of two events “There will be less than 17 named Atlantic storms in 2006,” and “There will be less than 9 named Atlantic storms in 2006.” Now, if crowds are really wise, if the markets are really smart, they’d know that the probability of the former must be higher than the probability of the latter. Whenever the latter is true, the former is also true, and there is also a set of possible outcomes for which the latter is false but the former is still true. Therefore, it must be more likely that the former occurs than that the latter occurs. Must, must, must.

And yet, at 11:00 pm EST last night, the cost of a share of “There will be less than 17 named Atlantic storms in 2006″ was equal to the cost of a share of “There will be less than 9 named Atlantic storms in 2006.” Each was selling at a price of 53 X dollars. That’s not wise. It’s foolish. It’s stupid, crazy, irrational.

The next time someone intones in condescending tones about the wisdom of a crowd, or about the intelligence of markets, or about how “millions can’t be wrong,” remember and share this little story. When crowds are all pushing in one direction, it’s not really a good idea to turn off the ol’ noggin and just go along. It’s crucial, especially as residents of a representative democratic republic in which what we think actually matters somewhat, that we keep our intellects intact, engaged, and always questioning.

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