Well, do the markets price these things, then? Let me draw a difference here.
The financial markets price credit risk. This means that from observable market prices I can calculate the implied probability of default for a given entity. The financial markets price, say, the future Fed decisions on rates—from observable market prices I can calculate the implied probability of the Fed raising or lowering the rates by a given amount at the next meeting.
I cannot calculate the implied probability of a nuclear exchange or of a pandemic from observable market prices.
With respect to your points,
I agree with (1), though I have doubts about the “better” part.
(2) seems meaningless to me: life creates bad incentives and bad behaviour. The fact that my neighbour has a shiny foozle and I don’t creates incentives for me to bonk him over the head and take his foozle.
For (3) I don’t know why you think so. There are financial markets in insurance and reinsurance risks (concerned with catastrophes like hurricanes and earthquakes), there are financial markets in sovereign debt (highly concerned with political risk) -- what’s so special about long-term catastrophic risk?
I disagree with (4) -- I see no reason to think it’s “unreasonable” :-) You’re making a naked assertion, it needs supporting arguments.
(5) is an empty phrase—everything has consequences.
So, you can calculate the implied probability of credit default because you can model credit obligations as priced by two factors only: yield and default risk. This is a crude model and won’t actually predict all bond prices in the real world (though it’ll come close), because people buy bonds for other reasons and the actual price of bonds tells you one fact: what people will pay for them. Everything else is just a model to get you there.
Apologies, because you know this. I’m not trying to patronize you. But please don’t patronize me. The fact that much more complicated factors that go into pricing stocks can’t easily be sussed out doesn’t mean they don’t exist. And it doesn’t mean that we can’t identify them ever, or ever see their significance. The fact that we cannot calculate something precisely doesn’t mean it’s useless.
It seems like the appeal of a betting market is that you would have something easy to understand. Not right, or sophisticated, or predictive. But you’d immediately be able to tell whether the George Mason Economics Department assigned 3:1 or 1:3 odds to Skynet emerging before 2037. It’s searching under the streetlamp.
2) Bad incentives in life have to be evaluated in context. We don’t have a foozle-bonking epidemic in Louisville, KY because of the rule of law in Louisville, KY. People in failed states worry all the time about foozle-bonking. People involved in large gambling arenas also worry all the time about foozle-bonking, because—and we don’t need a mechanism here, because we’ve got the history—other people involved in gambling respond poorly to the incentives of law and extremely poorly to the loss of their foozles.
3) If betting markets like this are limited to huge events hard for individuals or small cabals to influence, then sure, I see little problem. Nobody’s going to build Gray Goo to win a bet any more than anybody’s going to summon a hurricane magically, though people will and have destabilized governments to win bets against currencies. I was assuming a market like this would also bet on near-term mini-catastrophes. On things like swine flu making the jump again, or leaks of methyl parathion into water supplies. So maybe I’m conceiving of this incorrectly.
4) Two quick, imperfect thought experiments: I give you a million dollars to invest and access to your choice of five investment options. Do you give your money to
Goldman Sachs
Bridgewater Associates
PIMCO
A retired four-term US Senator of your choice starting a hedge fund with zero investing experience
The smartest three professors you can find in the George Mason Economics Department
Next, the betting market you want is established, and accumulates a total capitalization of about $100 million. There are many small bettors, but high net worth players include futurists, Cory Doctorow, the guys who wrote Freakonomics, the Ludwig von Mises Institute, the Danish royal family, and some whales who used to bet heavily on the NBA. In 2015, this market starts betting heavily that a certain start-up will unveil an android that can pass a meatspace Turing test while shooting pistols and riding a horse within the next ten years. You can in fact bet a dollar against a payoff of twenty dollars in this market if you don’t think this will happen. At the same time, this company’s stock plateaus, and you see that institutional investors are quietly exiting their positions while investment banks happily sell their shares to individual clients. The company’s IPO was pushed back as they looked for a new investment bank to handle their offering. How do you bet?
5) So is there any difference in defaulting when a bank owns the loan and when Charlie owns the loan? Charlie works out of the back of a liquor store and lists his occupation as “a little of this, a little of that.” The loan’s the same in the two cases, so Charlie and the bank take the same loss if/when you default.
So, you can calculate the implied probability of credit default because you can model credit obligations
Actually, no. I can calculate the implied probability because I can build an arbitrage trade and solve for the probability needed to make its expected return (adjusted for cost of capital, etc.) zero. If I forecast a different default probability I can put this trade on and expect to be paid for being right.
The fact that much more complicated factors that go into pricing stocks can’t easily be sussed out doesn’t mean they don’t exist.
Oh, they exist. But if you can’t “suss them out”, the usefulness of financial markets for estimating the probabilities involved in these factors is very limited, is it not?
..easy to understand
Depends on whether that is your goal. In many circumstances trading easiness of understanding for higher predictive power is a good trade-off.
I was assuming a market like this would also bet on near-term mini-catastrophes. On things like swine flu making the jump again, or leaks of methyl parathion into water supplies.
I don’t know if it would. Ireland has pretty well developed betting markets, you can bet on a large variety of political, etc. predictions there. I haven’t seen bets on poisoning water supplies—don’t forget that first you need a counterparty to take your bet, and second, your ability to collect might be compromised by nice gentlemen in black government cars who want to have a chat with you about that poisoning incident...
I give you a million dollars to invest...
I don’t understand the point. Are you making an argument about competency? Or are you saying that markets are not infallible?
In 2015, this market starts betting heavily...
I still don’t understand the point. No one is claiming that markets (in particular, prediction markets) are always right or always point you in the right direction. The are useful but not magical. The market price, as you know, is just a capital-weighted average of opinions. If the market participants are deluded or, for example, have different payoffs than you think, the market opinion will be “wrong”.
Prediction markets provide useful data. They are not a supernatural compass that is always correct.
I can calculate the implied probability because I can build an arbitrage trade and solve for the probability needed to make its expected return (adjusted for cost of capital, etc.) zero. If I forecast a different default probability I can put this trade on and expect to be paid for being right.
This is a distinction without a difference. The point is that prices can be thought of as reflecting just two variables, return and risk, while risk itself is extremely difficult to unpack. But that doesn’t mean we can’t unpack it at all, or gain valuable information about the chances of, say, bird flu.
Here’s a real world example of a very specific long term prediction pertinent to the LW community that I am willing to make based on the financial markets: cryogenics will fail. There is enough possible return on an investment in a successful cryogenics company that investors with long horizons would be flooding into the field if it were feasible.
Prediction markets provide useful data. They are not a supernatural compass that is always correct.
I agree completely.
We seem to disagree about what any sort of real-world catastrophe gambling market would look like, and the cost-benefit. Neither of us has a perfect real world example to point to, though InTrade et al. are somewhat similar, as are today’s sports betting markets. It sounds like you think this would wind up looking like InTrade, which doesn’t seem to involve many bad actors*. I think that to produce useful predictions it would have to be much larger, and look much more like the global sports betting market, which does involve many bad actors.
*edit: obviously, InTrade itself may have been a bad/criminal actor. But that’s not what we’re talking about, and I’m willing to stipulate that InTrade did not produce problems across the world.
This is rebuttal to your assertion that ”..is a crude model and won’t actually predict all bond prices in the real world”. The no-arbitrage approach does not depend on modeling credit obligations. It also doesn’t require thinking about which variables prices reflect.
There is enough possible return on an investment in a successful cryogenics company that investors with long horizons would be flooding into the field if it were feasible.
Huh? First, I don’t think long-term business prospects of cryogenics companies look good for the simple reason that they collect some money now and then have to pay costs for an indefinite period in the future. The long-term expected return is highly uncertain and can easily turn out to be negative. Second, from the purely investment perspective it doesn’t matter whether cryogenics would turn out to be feasible in reality, all you need is for sufficient number of people to believe so.
We seem to disagree about what any sort of real-world catastrophe gambling market would look like
Probably. Though, again, real-world catastrophe markets exist right now. There are easy ways to bet on, say, Miami being wiped out by a hurricane or on the Japanese financial system imploding under the weight of the sovereign debt.
The major difference from sports betting is that it’s easy to influence the outcome of a match. It’s not easy to increase the chance or the severity of a large-scale catastrophe.
Probably. Though, again, real-world catastrophe markets exist right now. There are easy ways to bet on, say, Miami being wiped out by a hurricane or on the Japanese financial system imploding under the weight of the sovereign debt. The major difference from sports betting is that it’s easy to influence the outcome of a match. It’s not easy to increase the chance or the severity of a large-scale catastrophe.
For whatever reason, and again, we don’t need to know the mechanism because we know the history, large numbers of gamblers behave differently than large numbers of investors. You can bet on a sports team doing well by buying the team, or buying real estate near the stadium or buying concessions rights in the stadium, or buying autographs to sell later on eBay, or you can bet through a bookie. The guys betting through bookies are the ones fixing matches, not the concessionaires. And they will go to extraordinary lengths to fix matches.
because we know the history, large numbers of gamblers behave differently than large numbers of investors.
That is not self-evident to me.
You can bet on a sports team doing well by buying the team … or you can bet through a bookie. The guys betting through bookies are the ones fixing matches …
I would strongly disagree. People owning the teams fix the entire system and so don’t need to fix individual matches. You do know that baseball owners have a special anti-trust exemption, right? Why do they need it and what do they do with it, you think?
Investors as opposed to gamblers fix thing on a much bigger scale and normally through politics. Agricultural subsidies? High import tariffs? That’s all the system being fixed for someone’s advantage.
I would strongly disagree. People owning the teams fix the entire system
You agree that the gamblers are fixing the matches. And I don’t disagree with you that owners are fixing the system.
Investors as opposed to gamblers fix thing on a much bigger scale and normally through politics. Agricultural subsidies? High import tariffs? That’s all the system being fixed for someone’s advantage.
You’re not wrong.
But whether or not investors and gamblers have equivalent senses of fair play, the latter is more likely to seek unlawful opportunities for profit. My point (5) above may have seemed silly, but there is a real difference between what a bank will do to you to recover money owed and what Charlie who works out the back of a liquor store will do, even though they have one incentive in common. And there is a big difference between what Aubrey McClendon will do to make sure his “bets” on oil wells pay off and what Joe who bets the fights will do to make sure his boxer wins.
And if Joe stumbles upon a group of people betting on the level of synthetic estrogen found in the metro’s tap water at a certain date...well, birth control pills are pretty cheap and impossible to trace.
But whether or not investors and gamblers have equivalent senses of fair play, the latter is more likely to seek unlawful opportunities for profit.
I still do not agree. I think there’s some confusion about cause and effect going on. Gambling used to be mostly illegal with all the consequences thereof—that’s where your “Charlie who works out the back of a liquor store” meme comes from.
Things have changed. Las Vegas and Indian casinos are full of law-abiding middle class people who want a little excitement and not looking to get into any trouble. They are gamblers, but they are not going to break anyone’s legs.
In any case, we’ve strayed far afield from the original question of whether markets where you can bet on catastrophes are a bad idea. Do you still think they are?
I agree that there’s a mostly safe and clean (but too often smoke-filled :( )space for gambling in the US now. There’s still a lot of shadiness in sports gambling, even though there are places to bet legally on games.
This has been a great exchange for me, and I appreciate it, so thank you! It’s helped me clarify my thinking on prediction markets.
I think niche prediction markets interested mostly in existential risk and AI are likely to be too small and eccentric to be good predictors, and that truly massive global predictions markets will involve shadiness. But I can see something in between, with real capital and a broad set of well-informed bettors, and some sort of mechanism to identify and track bettors, providing good information on near term events with little downside.
What do you think are the best and worse case scenarios for prediction markets?
What do you think are the best and worse case scenarios for prediction markets?
I don’t think that long-term prediction markets will have earthshattering consequences given that they will complement the existing financial markets.
Worst case: the US government (and others) continues to insist they’re illegal gambling, they don’t take off, nothing happens. I’m not considering movie-type scenarios in which an evil mastermind manipulates the prediction markets to fool the good guys and TAKE OVER THE WORLD!!!
Best case: the prediction markets do take off, become popular, continue to be independent and reasonably resistant to manipulation, and provide valuable data about the revealed predictions of the public.
Well, do the markets price these things, then? Let me draw a difference here.
The financial markets price credit risk. This means that from observable market prices I can calculate the implied probability of default for a given entity. The financial markets price, say, the future Fed decisions on rates—from observable market prices I can calculate the implied probability of the Fed raising or lowering the rates by a given amount at the next meeting.
I cannot calculate the implied probability of a nuclear exchange or of a pandemic from observable market prices.
With respect to your points,
I agree with (1), though I have doubts about the “better” part.
(2) seems meaningless to me: life creates bad incentives and bad behaviour. The fact that my neighbour has a shiny foozle and I don’t creates incentives for me to bonk him over the head and take his foozle.
For (3) I don’t know why you think so. There are financial markets in insurance and reinsurance risks (concerned with catastrophes like hurricanes and earthquakes), there are financial markets in sovereign debt (highly concerned with political risk) -- what’s so special about long-term catastrophic risk?
I disagree with (4) -- I see no reason to think it’s “unreasonable” :-) You’re making a naked assertion, it needs supporting arguments.
(5) is an empty phrase—everything has consequences.
So, you can calculate the implied probability of credit default because you can model credit obligations as priced by two factors only: yield and default risk. This is a crude model and won’t actually predict all bond prices in the real world (though it’ll come close), because people buy bonds for other reasons and the actual price of bonds tells you one fact: what people will pay for them. Everything else is just a model to get you there.
Apologies, because you know this. I’m not trying to patronize you. But please don’t patronize me. The fact that much more complicated factors that go into pricing stocks can’t easily be sussed out doesn’t mean they don’t exist. And it doesn’t mean that we can’t identify them ever, or ever see their significance. The fact that we cannot calculate something precisely doesn’t mean it’s useless.
It seems like the appeal of a betting market is that you would have something easy to understand. Not right, or sophisticated, or predictive. But you’d immediately be able to tell whether the George Mason Economics Department assigned 3:1 or 1:3 odds to Skynet emerging before 2037. It’s searching under the streetlamp.
2) Bad incentives in life have to be evaluated in context. We don’t have a foozle-bonking epidemic in Louisville, KY because of the rule of law in Louisville, KY. People in failed states worry all the time about foozle-bonking. People involved in large gambling arenas also worry all the time about foozle-bonking, because—and we don’t need a mechanism here, because we’ve got the history—other people involved in gambling respond poorly to the incentives of law and extremely poorly to the loss of their foozles.
3) If betting markets like this are limited to huge events hard for individuals or small cabals to influence, then sure, I see little problem. Nobody’s going to build Gray Goo to win a bet any more than anybody’s going to summon a hurricane magically, though people will and have destabilized governments to win bets against currencies. I was assuming a market like this would also bet on near-term mini-catastrophes. On things like swine flu making the jump again, or leaks of methyl parathion into water supplies. So maybe I’m conceiving of this incorrectly.
4) Two quick, imperfect thought experiments: I give you a million dollars to invest and access to your choice of five investment options. Do you give your money to
Goldman Sachs
Bridgewater Associates
PIMCO
A retired four-term US Senator of your choice starting a hedge fund with zero investing experience
The smartest three professors you can find in the George Mason Economics Department
Next, the betting market you want is established, and accumulates a total capitalization of about $100 million. There are many small bettors, but high net worth players include futurists, Cory Doctorow, the guys who wrote Freakonomics, the Ludwig von Mises Institute, the Danish royal family, and some whales who used to bet heavily on the NBA. In 2015, this market starts betting heavily that a certain start-up will unveil an android that can pass a meatspace Turing test while shooting pistols and riding a horse within the next ten years. You can in fact bet a dollar against a payoff of twenty dollars in this market if you don’t think this will happen. At the same time, this company’s stock plateaus, and you see that institutional investors are quietly exiting their positions while investment banks happily sell their shares to individual clients. The company’s IPO was pushed back as they looked for a new investment bank to handle their offering. How do you bet?
5) So is there any difference in defaulting when a bank owns the loan and when Charlie owns the loan? Charlie works out of the back of a liquor store and lists his occupation as “a little of this, a little of that.” The loan’s the same in the two cases, so Charlie and the bank take the same loss if/when you default.
Actually, no. I can calculate the implied probability because I can build an arbitrage trade and solve for the probability needed to make its expected return (adjusted for cost of capital, etc.) zero. If I forecast a different default probability I can put this trade on and expect to be paid for being right.
Oh, they exist. But if you can’t “suss them out”, the usefulness of financial markets for estimating the probabilities involved in these factors is very limited, is it not?
Depends on whether that is your goal. In many circumstances trading easiness of understanding for higher predictive power is a good trade-off.
I don’t know if it would. Ireland has pretty well developed betting markets, you can bet on a large variety of political, etc. predictions there. I haven’t seen bets on poisoning water supplies—don’t forget that first you need a counterparty to take your bet, and second, your ability to collect might be compromised by nice gentlemen in black government cars who want to have a chat with you about that poisoning incident...
I don’t understand the point. Are you making an argument about competency? Or are you saying that markets are not infallible?
I still don’t understand the point. No one is claiming that markets (in particular, prediction markets) are always right or always point you in the right direction. The are useful but not magical. The market price, as you know, is just a capital-weighted average of opinions. If the market participants are deluded or, for example, have different payoffs than you think, the market opinion will be “wrong”.
Prediction markets provide useful data. They are not a supernatural compass that is always correct.
This is a distinction without a difference. The point is that prices can be thought of as reflecting just two variables, return and risk, while risk itself is extremely difficult to unpack. But that doesn’t mean we can’t unpack it at all, or gain valuable information about the chances of, say, bird flu.
Here’s a real world example of a very specific long term prediction pertinent to the LW community that I am willing to make based on the financial markets: cryogenics will fail. There is enough possible return on an investment in a successful cryogenics company that investors with long horizons would be flooding into the field if it were feasible.
I agree completely.
We seem to disagree about what any sort of real-world catastrophe gambling market would look like, and the cost-benefit. Neither of us has a perfect real world example to point to, though InTrade et al. are somewhat similar, as are today’s sports betting markets. It sounds like you think this would wind up looking like InTrade, which doesn’t seem to involve many bad actors*. I think that to produce useful predictions it would have to be much larger, and look much more like the global sports betting market, which does involve many bad actors.
*edit: obviously, InTrade itself may have been a bad/criminal actor. But that’s not what we’re talking about, and I’m willing to stipulate that InTrade did not produce problems across the world.
This is rebuttal to your assertion that ”..is a crude model and won’t actually predict all bond prices in the real world”. The no-arbitrage approach does not depend on modeling credit obligations. It also doesn’t require thinking about which variables prices reflect.
Huh? First, I don’t think long-term business prospects of cryogenics companies look good for the simple reason that they collect some money now and then have to pay costs for an indefinite period in the future. The long-term expected return is highly uncertain and can easily turn out to be negative. Second, from the purely investment perspective it doesn’t matter whether cryogenics would turn out to be feasible in reality, all you need is for sufficient number of people to believe so.
Probably. Though, again, real-world catastrophe markets exist right now. There are easy ways to bet on, say, Miami being wiped out by a hurricane or on the Japanese financial system imploding under the weight of the sovereign debt.
The major difference from sports betting is that it’s easy to influence the outcome of a match. It’s not easy to increase the chance or the severity of a large-scale catastrophe.
For whatever reason, and again, we don’t need to know the mechanism because we know the history, large numbers of gamblers behave differently than large numbers of investors. You can bet on a sports team doing well by buying the team, or buying real estate near the stadium or buying concessions rights in the stadium, or buying autographs to sell later on eBay, or you can bet through a bookie. The guys betting through bookies are the ones fixing matches, not the concessionaires. And they will go to extraordinary lengths to fix matches.
That is not self-evident to me.
I would strongly disagree. People owning the teams fix the entire system and so don’t need to fix individual matches. You do know that baseball owners have a special anti-trust exemption, right? Why do they need it and what do they do with it, you think?
Investors as opposed to gamblers fix thing on a much bigger scale and normally through politics. Agricultural subsidies? High import tariffs? That’s all the system being fixed for someone’s advantage.
You agree that the gamblers are fixing the matches. And I don’t disagree with you that owners are fixing the system.
You’re not wrong.
But whether or not investors and gamblers have equivalent senses of fair play, the latter is more likely to seek unlawful opportunities for profit. My point (5) above may have seemed silly, but there is a real difference between what a bank will do to you to recover money owed and what Charlie who works out the back of a liquor store will do, even though they have one incentive in common. And there is a big difference between what Aubrey McClendon will do to make sure his “bets” on oil wells pay off and what Joe who bets the fights will do to make sure his boxer wins.
And if Joe stumbles upon a group of people betting on the level of synthetic estrogen found in the metro’s tap water at a certain date...well, birth control pills are pretty cheap and impossible to trace.
I still do not agree. I think there’s some confusion about cause and effect going on. Gambling used to be mostly illegal with all the consequences thereof—that’s where your “Charlie who works out the back of a liquor store” meme comes from.
Things have changed. Las Vegas and Indian casinos are full of law-abiding middle class people who want a little excitement and not looking to get into any trouble. They are gamblers, but they are not going to break anyone’s legs.
In any case, we’ve strayed far afield from the original question of whether markets where you can bet on catastrophes are a bad idea. Do you still think they are?
I agree that there’s a mostly safe and clean (but too often smoke-filled :( )space for gambling in the US now. There’s still a lot of shadiness in sports gambling, even though there are places to bet legally on games.
This has been a great exchange for me, and I appreciate it, so thank you! It’s helped me clarify my thinking on prediction markets.
I think niche prediction markets interested mostly in existential risk and AI are likely to be too small and eccentric to be good predictors, and that truly massive global predictions markets will involve shadiness. But I can see something in between, with real capital and a broad set of well-informed bettors, and some sort of mechanism to identify and track bettors, providing good information on near term events with little downside.
What do you think are the best and worse case scenarios for prediction markets?
I don’t think that long-term prediction markets will have earthshattering consequences given that they will complement the existing financial markets.
Worst case: the US government (and others) continues to insist they’re illegal gambling, they don’t take off, nothing happens. I’m not considering movie-type scenarios in which an evil mastermind manipulates the prediction markets to fool the good guys and TAKE OVER THE WORLD!!!
Best case: the prediction markets do take off, become popular, continue to be independent and reasonably resistant to manipulation, and provide valuable data about the revealed predictions of the public.
Nothing horribly exciting here :-)