I think of the difference as: a prediction market is subsidized by someone with an interest in the information (or participants who want to influence some decision-maker who will act on the basis of market prices), while a financial market facilitates trade (or as a special case hedges risk).
How is a prediction market subsidized by someone with an interest in the information? As far as I’m aware, most of them make money on bid/ask spreads, and can be thought of as a future or Arrow–Debreu security.
As the current institutions stand there are differences. Prediction market sites and the Nasdaq are obviously different in a lot of institutional ways. In prediction markets you can’t own companies. But in the more abstract way in which people trade on current information as a prediction, which is eventually realized, they are similar.
For example, a corporate bond is going to make a series of payments to the holder over its maturity. Market makers can strip off these payments and sell them as bespoke securities, so you could buy the rights to a single payment on debt from company X in 12 months. If you’d like, people can then write binary options on those such that they receive everything or nothing based on a specified strike price.
In the general security there is lots of information and dynamics, but with the right derivatives structure you can break it up into a state of a series of binary predictions.
The dynamic structure behind prediction markets and financial markets as trading current values built on models of future expectations is very similar, and I think identical.
I agree with you that there is no difference in kind between the assets traded in existing financial markets and those traded in a prediction market.
Existing prediction markets primarily offer amusements to participants, and are run like other gambling sites, with a profit to the market and the average trader losing money. Existing markets may hedge some participants’ risk, and in that respect are like a financial market.
Around here, prediction markets are usually proposed as an institution for making predictions (following Robin). In that context, someone who wants a prediction subsidizes the market, perhaps by subsidizing a market maker. The traders aren’t trading because it’s fun or they have a hedging interest, they are doing it because they are getting paid by someone who values the cognitive work they are doing.
In some cases this is unnecessary, because someone has a natural interest in influencing the prediction (e.g. if the prediction will determine whether to fire a CEO, then the CEO has a natural interest in ensuring that the prediction is favorable). In this case the decision-maker pays for the cognitive work of the traders by making a slightly suboptimal decision. Manipulative traders pay for the right to influence the decision, and informed traders are compensated by being counterparties to a manipulative trader.
I think this is the important distinction between a prediction market and other kinds of markets—in the case of prediction markets, traders make money because someone is willing to pay for the information generated by the market. I agree that this is not the case for existing prediction markets, and so it’s not clear if my story is reasonable. But it is clear that there is a difference in kind between the intended use of prediction markets and other financial markets.
I think of the difference as: a prediction market is subsidized by someone with an interest in the information (or participants who want to influence some decision-maker who will act on the basis of market prices), while a financial market facilitates trade (or as a special case hedges risk).
How is a prediction market subsidized by someone with an interest in the information? As far as I’m aware, most of them make money on bid/ask spreads, and can be thought of as a future or Arrow–Debreu security.
As the current institutions stand there are differences. Prediction market sites and the Nasdaq are obviously different in a lot of institutional ways. In prediction markets you can’t own companies. But in the more abstract way in which people trade on current information as a prediction, which is eventually realized, they are similar.
For example, a corporate bond is going to make a series of payments to the holder over its maturity. Market makers can strip off these payments and sell them as bespoke securities, so you could buy the rights to a single payment on debt from company X in 12 months. If you’d like, people can then write binary options on those such that they receive everything or nothing based on a specified strike price.
In the general security there is lots of information and dynamics, but with the right derivatives structure you can break it up into a state of a series of binary predictions.
The dynamic structure behind prediction markets and financial markets as trading current values built on models of future expectations is very similar, and I think identical.
I agree with you that there is no difference in kind between the assets traded in existing financial markets and those traded in a prediction market.
Existing prediction markets primarily offer amusements to participants, and are run like other gambling sites, with a profit to the market and the average trader losing money. Existing markets may hedge some participants’ risk, and in that respect are like a financial market.
Around here, prediction markets are usually proposed as an institution for making predictions (following Robin). In that context, someone who wants a prediction subsidizes the market, perhaps by subsidizing a market maker. The traders aren’t trading because it’s fun or they have a hedging interest, they are doing it because they are getting paid by someone who values the cognitive work they are doing.
In some cases this is unnecessary, because someone has a natural interest in influencing the prediction (e.g. if the prediction will determine whether to fire a CEO, then the CEO has a natural interest in ensuring that the prediction is favorable). In this case the decision-maker pays for the cognitive work of the traders by making a slightly suboptimal decision. Manipulative traders pay for the right to influence the decision, and informed traders are compensated by being counterparties to a manipulative trader.
I think this is the important distinction between a prediction market and other kinds of markets—in the case of prediction markets, traders make money because someone is willing to pay for the information generated by the market. I agree that this is not the case for existing prediction markets, and so it’s not clear if my story is reasonable. But it is clear that there is a difference in kind between the intended use of prediction markets and other financial markets.