Monday, May 9, 2011

Chronicle of a Death Not Foretold

Intrade is an online "prediction market." The basic idea is that markets aggregate a lot of information from many dispersed individuals trying hard to make money, and so they can usually make better predictions than individuals can. That's why most economists consider the stock market valuation of a company to be the best measure of its value.

Intrade capitalizes on this idea by setting up speculative markets in particular outcomes to be predicted. For example, they might sell shares that (to simplify slightly) will pay $1 if the Higgs Boson subatomic particle is discovered by December 31, 2011, and zero if it isn't. Then if shares are selling for $0.20, as they are, you can interpret that as the market estimating that there is a 20% chance of the Higgs Boson being discovered in 2011. (There are some big caveats here, including whether enough people are participating in this market to give you a good estimate.)

Of course, one of the things people are most interested in forecasting is election results. Recently the Intrade market was predicting the Obama had around a 60% chance of being reelected. That seemed a little low to me, so I briefly thought that I should buy some shares, but of course I didn't.

I am not proud that when I learned of the demise of Osama bin Laden, almost the first thing I thought was, "Damn! I should have bought some stock in Obama." And sure enough, when I looked at the data it looked like this:

If I'd actually had some, mind you, I might have cashed in right away instead of waiting until November 2012. There's a lot that can happen between now and then. Anyone who remembers the first Gulf War probably remembers the surrendering Iraqi soldiers chanting "George Bush! George Bush!" President Bush's approval rating in 1991 reached a staggering 89 percent, yet he lost the 1992 elections. As the Clinton campaign staff famously observed, it's the economy, stupid.

Indeed, it's not sure that I would've had time to cash in, for many people seemed to have had the same thought:

Now a share of Obama really looks undervalued to me, because whatever his probability of reelection was on May 1, it's hard to believe that getting bin Laden only raised it by one percentage point. So am I going to buy some? Don't rush me-- I'm thinking.

Incidentally, if you ever need proof of the proposition that sometimes politicians should stay out of things they don't understand and let the technocrats do their jobs, take a look at the feast of moral outrage and sanctimony that transpired when a couple of senators got wind of plans by the Defense Advanced Research Projects Agency to set up a prediction market on the future of the Middle East. Alas, we'll never know what the market would have said about the probability of democratic uprisings. And strangely, there seems never to have been a market at Intrade on the probability of finding bin Laden.

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