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The Idiocy Of Prediction Markets Illustrated With 2016 Republican Contest

For a while now, there’s been an economic school of thought that supposes that people in crowds are inherently better decision makers than individuals can be. This idea comes out of the capitalist faith in an invisible hand that somehow guides markets to the optimum outcomes.

For over a decade now, this idea has been applied in the political sphere, with prediction markets, where people bet on the chance that certain political events, such as the victory of a candidate in a particular election, will take place. In these markets, people can trade options on these outcomes, so their value fluctuates as the invisible hand of the market moves slowly but surely toward its optimized prediction.

That’s the theory, anyway. The reality, as shown in this graph from a prediction market for the 2016 Republican presidential nomination shows.

prediction markets get 2016 GOP race wrong

The graph, from ElectionBettingOdds.com, shows that just a half a year ago, the prediction market gave Donald Trump a 10 percent chance of winning the Republican presidential nomination, and said that Jeb Bush was most likely to win the race. However, by the beginning of this month, the market had changed its mind almost completely, giving Trump an 80 percent chance of victory in the Republican contest. Now, after Donald Trump’s latest round of off-the-cuff absurdities trampled on the GOP’s holy-of-holies (abortion), the prediction market gives Trump just over a 50 percent chance of winning, although the chances of Trump’s main opponents, Ted Cruz and John Kasich, hasn’t grown by much in response. Apparently, the markets believe that some mysterious person not currently running for President has a good chance of winning the Republican nomination.

The current dip really isn’t a low point for Donald Trump, as far as this prediction market is concerned. Trump’s likelihood of winning the Republican nomination, in the market’s eyes, plummeted from 50 percent to below 25 percent back at the beginning of February. Remember what happened then? Trump lost the Iowa caucuses.

The rapidity with which the market’s predictions changed then reveals what kind of market it really is. It’s not making predictions. It’s showing reactions. The market supposed Donald Trump was the favorite on the day before the Iowa caucuses, and then, suddenly, after Trump lost that contest, the market had a new version of reality to work with.

The repeated failure of ElectionBettingOdds.com to provide a consistent predictive view of the Republican presidential race shows that there really isn’t any invisible hand guiding markets in a reliable way. Crowds of people don’t have particularly reliable, or even constant, predictive insight. What we see in this prediction market is about the same as what we would get from watching the TV news, or asking random people on the street what their opinion is – and both of those sources are frequently inaccurate.

There isn’t any magic that happens when you expose an idea to a marketplace. A marketplace, it turns out, is just a bunch of people making guesses about the future, based on inaccurate and incomplete information.

They’re gamblers, trading options based on what they think the odds are on any particular day.

If there’s anything we know about gamblers, it’s that, on average, they’re wrong. On average, they lose.

Why should we hold any trust in groups of gamblers like those at ElectionBettingOdds.com to predict what our political future will bring?

7 thoughts on “The Idiocy Of Prediction Markets Illustrated With 2016 Republican Contest”

  1. Korky Day says:

    There are so many straw-person arguments and other mistakes there, ‘Rowan’, it’s hard to know where to begin.
    You certainly don’t understand the mathematics. Or the politics.
    I’m not defending capitalism. I’m against capitalism, especially in its pure form.
    Rather, I’m defending the math and politics.

    You scorned the idea that ‘people in crowds are inherently better decision makers than individuals can be.’
    They sure are. That’s why democracies are generally better than dictatorships.

    But you confuse decision-making with prediction. 2-different things, I hate to tell you.
    Crowds are also better predictors than individuals, other things being equal.
    For instance, a crowd of randomly picked people would usually be better at predicting than would one randomly picked person.
    That’s statistics.

    Your next folly was choosing an example in progress. We have no way yet to tell how accurate or inaccurate any of those predictions are.
    Why not pick an example from a past election?

    Next, you misunderstand how and why predictions change. The more you learn, the better you can predict. So, over time, your prediction will get better and better. Nothing shameful or inaccurate about predictions changing over time. In fact, it would be stupid if they didn’t.

    Then you write, ‘Apparently, the markets believe that some mysterious person not currently running for President has a good chance of winning the Republican nomination.’
    Yes, they do believe that. Such as Mitt Romney. He does have a chance of being the next president. Not a big chance, but a chance nonetheless.
    And the ‘market’ knows that. I’m against a market-ruled economy, but the ‘market’ certainly is smart enough to know that Romney does have a (slim) chance. You aren’t, I guess.

    You, ‘Rowan’, want to substitute your own predictive skills as more accurate than a crowd. I guess Trump isn’t the only one with a big head.
    If you really believed that, you’d bet against all those stupid people in the crowd. Make a bundle. Retire early. Or donate your winnings to a good cause. Go ahead, I dare you. If you won’t, then I guess you just want us to think you’re smarter than the crowd, so if we bet our money on your predictions, you won’t lose! Oh, I forgot. You are not making a prediction. Coward?

  2. J Clifford says:

    “We have no way yet to tell how accurate or inaccurate any of those predictions are.”

    Korky, the fact that this prediction market has already made two incompatible predictions – that Donald Trump is almost certainly not likely to win the nomination, and then that Donald Trump is near certain to win the nomination – overcomes this objection, I think.

  3. Korky Day says:

    J Clifford is now making the same mistake that ‘Rowan’ did. No, a prediction is based on probabilities. Probabilities change. Certainties don’t.

    So when you bet, you get odds. Romney has 201 to 1 odds at
    http://www.oddschecker.com/politics/us-politics/us-presidential-election-2016/winner

    If you are not willing to bet against Romney with those odds, then you fear he will more likely win than that.
    But the odds change as events occur which, naturally, change the odds. You don’t ‘get’ that.
    If you notice your race horse suddenly starts limping, you’re less likely to bet on her winning. If you ‘get’ it.

  4. Korky Day says:

    To clarify, Romney has 201 to 1 chance of losing. One chance in 201 of winning.

  5. Korky Day says:

    Ralph Nader now predicts that Donald Trump won’t be the next president.
    https://blog.nader.org/2016/04/01/trumps-self-inflicted-fall/

    In the articles he says, ‘There are downsides to Trump’s forthcoming fall. Trump took on the corporatist trade treaties and the hollowing out of jobless communities throughout the land. He touted the need for massive public works projects. He consistently condemned Hillary’s support of the Iraq war as Senator, and her lead role in leading the way for the Libyan overthrow and the resultant spreading violent chaos in northwest and central Africa when she was Secretary of State. He stuck it to Hedge Fund billionaires with their brazen tax escapes.
    It will be a while before you see a major Republican Presidential candidate stake out these positions day after day.’

    I still think Trump has a very good chance, that he’s smart enough for a turn-around.
    There are 2 guesses for you.

  6. Dave says:

    Rowan, I think you’re confusing predictions with commodities. Apparently it’s getting difficult to make a case against the Invisible Hand of the marketplace.

    Korky’s right. This is democracy.

  7. Korky Day says:

    Thanks, Dave.
    The ‘invisible hand’ certainly works. The question is how much will we let it rule us. It’s our choice.

    I showed all of the above to a professor of mathematics (statistics and probability).
    She said that I was right on all my mathematical points, but that I was much too harsh and rude to my fellow arguers such as J Clifford and Rowan.

    So I thank the professor and apologize to those who might have felt offended.
    My intention, which I now realize might not have been clear, was to express some jocular, collegial ribbing among people enjoying an argument.
    I’m sorry if it didn’t read that way.
    I would revise my comments if I were allowed to, as I am on Facebook.

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