I’m discussing prediction markets outside of financial markets. I don’t think most people would consider financial markets under ‘prediction markets’, though I obviously realize there are similarities.
Literally the only difference in terms of prediction dynamics is that currently prediction markets include political/non-financial questions, which are only implicitly included in 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.
I’m discussing prediction markets outside of financial markets. I don’t think most people would consider financial markets under ‘prediction markets’, though I obviously realize there are similarities.
You are talking about terminology: whether most people call financial markets a kind of prediction markets.
I’m pointing out that “prediction technologies” are basically the same for both, regardless of what is called what.
Literally the only difference in terms of prediction dynamics is that currently prediction markets include political/non-financial questions, which are only implicitly included in 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.