Prediction Markets Are About Being Right

Response To (Marginal Revolution): If you love prediction markets you should love the art world.

Previously on prediction markets: Prediction Markets: When Do They Work?Subsidizing Prediction Markets

I’ll quote the original in full, as it is short, and I found it interestingly and importantly wrong. By asking the question of why this perspective is wrong, we see what is so special about prediction markets versus other markets.

Think of art markets, and art collecting, as an ongoing debate over what is beautiful and also what is culturally important.  But unlike most debates, you have a very direct chance to “put your money where your mouth is,” namely by buying art (it is very difficult to sell art short, however).  In this regard, debates over artistic value may be among the most efficient debates in the world.  At least if you are persuaded by the basic virtues of prediction markets.  The prices of various art works really do aggregate information about their perceived values.

I have, however, noted a correlation, how necessary or contingent I am not sure.  The “white male nerd types” who are enamored of prediction markets tend to be especially skeptical of the market judgments of particular art works, most of all for conceptual and contemporary art.

In my view, discussions about the value of art, as they occur in the off-the-record, proprietary sphere, are indeed of high value and they deserve to be studied more closely.  Imagine a bunch of people competing to make “objects that are interesting but not interesting for reasons related to their practical value.”  And then we debate who has succeeded, or not.  And those debates reflect many broader social, political, and economic issues.  And it is all done with very real money on the line.  The money concerns not just the value of individual art works, but also the prestige and social capital value that arises from having assembled a prestigious and insightful collection.

That’s exactly why (almost) everyone who loves prediction markets hates the high-end, expensive art markets, even if they love art and artists and buy original paintings to hang on their walls. This goes beyond ‘skepticism of the market judgments.’ Expensive art markets are not fundamentally markets. They are fundamentally a political status game.

Consider three (non-exhaustive) types of markets: Consumption markets, commercial markets and prediction markets.

Consumption markets are where the buyer is buying the item in order to use it.

The buyer who pays more than necessary is sad in one sense, and the one who got the best deal is happy in that sense. But that sense isn’t the important one for the buyer. If you are ‘right’ it is because you indeed got good use of the item that justified the purchase. If you are ‘wrong’ it is because you didn’t.

Thus, we can point to a ‘naive’ participant who doesn’t ‘play the game’ of that market, and say ‘look how much they could have saved’, or did ‘save’, but that doesn’t actually impact them.

Liquid commercial markets are where the buyer plans to sell the item to someone else.

Middle men, arbitrage, investment, greater fools, that sort of thing. Buy low, sell high.

If you buy a stock, or a commodity piece of art, or inventory for your store, or a cryptocurrency, and others want to buy it for more, it goes up in price and you make money. If they want to sell it for less, it goes down in price and you lose money.

The buyer who pays more than necessary is sad, and loses money, in the only sense that matters. If the price goes down, that too makes the buyer sad. Paying a locally good price, or having the price go up, makes the buyer happy. The key is to buy before others buy, so they drive the price up.

You might reply, no, the bigger key is to buy what is cheap and sell what is expensive, based on fundamentals, and that will bear out over time.

Well, maybe.

Yes, often buyers and sellers are driven by fundamentals. But in an important sense, that is a coincidence. What is actually good news is often considered bad news, and vice versa. Prices are often largely driven by who is thinking about what and the emotional state and financial needs of participants. The market can stay insane longer than you can stay solvent. The people who say such non-fundamental movements are random, are mostly saying they aren’t good enough to understand and predict them in this case.

Yes, eventually fundamentals might take over.  Or they might not. Low prices cause damage or make items impossible to justify storing or stocking. High prices trigger media attention and create opportunity. Low prices trigger margin calls, gets the company bought out or its employees and partners to quit. High prices trigger short squeezes and make everyone want to work with and for you. And so on. Momentum trading works, damn it (like everything else on this blog, not investment advice!).

Ideally the commercial market is anchored by connection to a consumption market – someone wants the goods, or is willing to collect the profits from the stock, or what not. The stronger that anchor versus speculative factors, the more accurate the prices.

Prediction markets have elements of both.

Prediction market traders can choose to mostly act like traders. If you think that others will think that the Patriots will win next week, you can bet on the Patriots now and then bet against them later when the odds change, and make money. You can be a market maker, or a block trader, or any other traditional market role.

In doing this, a trader cares about future social reality. They are people predicting what others will, in the future, predict that others will predict that others will predict, and so on. World events can help or hurt them, as they change perception, but they care about that perception and not the reality. By the time reality sets in, who knows what positions the trader will have?

In prediction markets there is another option. You can care about future reality. The market predicts a future outcome, and importantly you can stay solvent longer than the market can stay insane. Either the Patriots will win next week, or they will not. You can do better by using your commercial market tactics to grab the best possible price on the Patriots winning or losing, but the important thing is that you win if you are right about the concrete thing, and you lose if you are wrong. 

This works because there is an objective outcome, and it occurs quickly. Thus it functions in its own way like a consumption market.

Truth matters. 

If you choose, only truth matters. I don’t have to care what other people think. They don’t determine if I win or lose.

That’s what I love, more than anything, about prediction markets. That’s the reason behind many of the requirements of well-functioning prediction markets: They enable this sole reliance on truth, without imposing virtual taxes via long lock-up periods. This also enables prediction markets to output accurate predictions.

That’s also a lot of what I love about trading. With a sufficiently deep and liquid market, you win if and only if you are right. No one gets to take that away from you and decide who gets the credit and the money. Only your skill mattered, and you reap what you deserve.

strongly encourage the type of people who read this blog to strive to identify and work in such realms. Be where being right, rather than being approved of, is rewarded. 

The world mostly does not work like this.

The world mostly hates prediction markets, because they predict concrete consequences and outcomes accurately without taking into account what those in power, with high social status, want to be the prediction. 

Mostly, winners and losers are determined by social processes, status, coalitions, power, money and so on.

Credit and compensation mostly isn’t based on who knew the truth and predicted accurately, or who did the work or created the value, or even what was stated in the contract. It is based on who has power and what they decide, based on what is good for them. History, along with everything else, gets decided by the winners.

That’s life.

That’s also expensive art, and expensive art markets, of the type Tyler speaks of. Only more so.

As I understand it (from, mostly, following Marginal Revolution links and posts) a small group determines who succeeds and fails, and buys art from each other, and manipulates the social reality of the art world and its prices to suit its fancies. Its fancies are mostly about the pursuit of conspicuous consumption, high social status and its associated rewards, wealth storage, money laundering and tax evasion, plus suckering outsiders and scamming them out of their money. Artistic merit, or aesthetics, are mostly a minor consideration.

Recall Tyler’s description:

Imagine a bunch of people competing to make “objects that are interesting but not interesting for reasons related to their practical value.”  And then we debate who has succeeded, or not.  And those debates reflect many broader social, political, and economic issues.  And it is all done with very real money on the line.  The money concerns not just the value of individual art works, but also the prestige and social capital value that arises from having assembled a prestigious and insightful collection.

In this context, what does it mean for an object to ‘be interesting’? It means having a high price, but mostly it means being judged as interesting by a high social status cabal that is primarily designed as an alliance of the high status connected people against everyone else. This need not be explicit at all – it is how such people instinctively operate, and you either learn those instincts or you never make it into the club.

There is no reason think any of this will ever “return to fundamentals” in any sense. The system sustains itself. There is (almost) no there, there. There never will be.

Thus, if I buy art, and people don’t like me, they will find ways to charge me a lot more then they’d have charged an insider, and then they say therefore my art is not so valuable. Because I was buying it, and now I own it.

If I hadn’t bought that piece, would it have become valuable? We’ll never know. Was it valuable before I bought it? Also impossible to say.

That game is rigged, man. The only way to win is not to play.

If I think those people are wrong, I can consume the art by displaying it in my house and admiring it. If I want to spend a few hundred or thousand dollars on something I love, by all means I should go for it, but have zero illusions about the work becoming ‘valuable.’

What I cannot do is predict that they are wrong, and wait for events to prove me right. There is no judgment day. No profit stream. No right. No wrong.

There are only cliques who watch each other to see if they are favoring the others in the clique, and use this to exploit others, because that’s what winners and clique members with power and money do. It’s sort of a market, like everything else. But in important senses, it is badly named, and something people like me despise. It is our failure mode and our doom, the way that prediction markets are our success mode and our hope.

Thus, if you love art markets you likely despise prediction markets, at least outside of their designated safe areas like sports and elections. And if you love prediction markets, you likely despise art markets whether or not you find them informative and fascinating in their own way.

What none of the people, whether they love or hate either market type, should be fooled by, is in accepting in a non-skeptical fashion the ‘market prices’ of ‘art’ in the art market. That is flat out not what is going on, at all. Such trades are not about the exchange of cash value for art value. Trying to use them to value the artwork misses the point entirely.

Are these art-market games worth understanding for what they can teach us about the world and how people work? Absolutely. Such shadowy practices do not get the light shined on them, that they deserve. Scams and exploitation and manipulation should be exposed. Political games as well. To blame and ideally punish those responsible, to protect people against them and against having to play such games to succeed. But more than that, to educate us about how people, and how such systems, work. Mostly, those who do understand how such things work only understand them from the inside, and do so in a non-intellectual fashion. With exposure, and as they see such actions succeed, they adopt their actions, views, instincts and very identity towards perpetuating such systems through imitation, usually without ever understanding what is going on in either themselves or the system at large.

Actually understanding how such things work might be the first step towards containing or overcoming such systems, or at least minimizing the damage they inflict on our lives, our status, our wealth and our souls.

It is also possible that such systems are in fact how anything actually gets done at all, and the exposure of more and more hypocritical and exploitative systems is making society unable to function, which would be far worse.

That’s a risk I am willing to take.

 

 

 

 

 

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13 Responses to Prediction Markets Are About Being Right

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  2. Doug S. says:

    To the extent that financial markets act like a Keynesian beauty contest – in which the important thing is to anticipate what the other participants think, rather than to evaluate the underlying asset accurately – we generally consider them failing or distorted. (Consider the market for Beanie Babies…)

  3. Doug S. says:

    “If you really think of it, when a stock doesn’t pay dividends, there really isn’t a whole lot of difference between a share of stock and a baseball card.

    If you put your Mickey Mantle rookie card on your desk, and a share of your favorite non-dividend paying stock next to it, and let it sit there for 20 years. After 20 years you would still just have two pieces of paper sitting on your desk.”

    – Mark Cuban

  4. To get a visceral sense of how insane the art world is in the West, visit any contemporary art museum in East Asia. The MoCA in Bangkok has more beautiful 21st-century art that all the galleries in New York combined, and I bet that judgment would be shared by the majority of viewers who aren’t professionals in the art game.

    It’s not a matter of different tastes in Asia and the West; every westerner I know who visited MoCA Bangkok came back delighted. And it’s not a difference in tastes between museum curators and the general public either – being excluded from competing in the art-signaling game because of their limited budgets and lack of status, the Thai art curators are free to hang beautiful art on their walls.

    The best showcase of art in New York is the Affordable Art Fair. The word “Affordable” explicitly excludes it from being a high-status thing (even though many pieces are priced at $10,000), so you’re allowed to show art that’s actually good.

  5. srconstantin says:

    I’m confused on one point: why don’t commercial markets *also* have a “judgment day”?
    Companies go bankrupt — your stock is definitely worthless if that happens. (But I guess you’re saying that’s too slow or unlikely to be a strong driver of behavior?)
    Stock can pay out dividends too, right? Which would make the stock market more like a “consumption market”? (This is where I honestly don’t know how it works well enough.)

    • TheZvi says:

      If you are Warren Buffet or otherwise on a super-long, buy-and-hold time frame, you can indeed be a consumer in a commercial (stock or similar) market, by buying the profit stream, or potentially shorting the company and paying the profit stream although that’s trickier on many levels. I like to think I’m using it that way. But the participants driving the prices are mostly not doing this, although some people prepared to do that anchor things and hold it in check.. somewhat.

      The key thing about judgment day is that it’s a day, and you know the day, and can easily and cheaply hold on until that day. That’s very different from an uncertain time frame of years or decades, or even months.

    • Quixote says:

      In addition to the stock markets for Warren Buffet and other long term investors, other markets also have days where things resolve. In the bond markets, short and medium term bonds have a maturity date when payment comes due in full and they also have periodic interest payments where missing a payment would be a ‘decisive moment of resolution’. In the futures and derivative markets, most instruments also have relatively short term end points and payout if and only if certain conditions are true on those dates.

      The bond market has long had a reputation for being “smarter” than the stock market. I’ve historically just attributed this to hiring smarter people, but the dynamic Zvi identifies here of having specific days when things resolve and are compared to objective reality is probably a more likely explanation.

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  8. TheZvi says:

    Welcome, everyone who comes here from Marginal Revolution. Always grateful when Tyler sends people my way. Go to the About page if you’d like to see what this blog has historically had to offer; right now, I’m in the middle of a distinct gaming-related sequence of narrower interest, which will end soon.

    On Tyler’s link he notes: I mostly disagree with the portrait of each, and would even suggest that prediction markets have more to do with their own kind of social status than art markets do.

    As you would expect, I don’t agree, but I find the suggestion interesting to ponder.

    One way to interpret it is to view being right/probable/accurate as largely a status claim, prediction markets as a fight between such claims and as a general claim against the outside world. Certainly there is an ongoing argument from a select few (e.g. Hanson and friends) that prediction markets ought to be used and have high status, and other forms of prediction and measurement should be given relatively low status, and thus the markets themselves could then be seen as about status. This seems like part of the whole everything-is-status view – right now decisions are made largely based on status, and to challenge that is to claim to be able to make decisions or be justified in doing so, which is therefore a huge status claim. While proponents would claim that this is about disentangling status from truth/decisions/rewards, which could even be called ‘lowering the status of status.’ So meta.

    Another way of reading it might be, in the art world status is less based on money than in the prediction market world, which is explicitly about money and reward, and thus is about evaluating people and their status through measured accuracy, profit and loss – you’re figuring out who is right and this is very bound up in status questions. Whereas in art, there is a level or two of distinction and indirect cause here. The high status are too high status to concern themselves with crass matters, and any obsession with numbers, math or details would be crass and low status. Which is quite the twisted game such people play to run over us other folk.

    Of course, given who wrote it, it’s probably something else entirely.

  9. Edward Elliott says:

    Hi TheZvi,

    Great article, thanks for taking the time to write it. I really enjoyed the body but thought the last two (or is it three?) paragraphs were weak conclusions and undermine the analysis of the article with a touch of bitterness. In fact the article tends towards an emotional ‘but they didn’t pick me!’ outlet.

    I think the formation of such networks is human in nature, and doesn’t affect only the rich. For example, why does one punk rock band get popular over another similarly sounding punk rock band? Because the ‘elites’ of the emos decided so. Part of competing to lead a group is to have your opinions adopted (and it doesn’t matter whether they are in fact your opinions – see policy positions of politicians). It’s great to recognise this as you say, but we shouldn’t be bitter about not being part of a group. Either compete to take over the group or join the rank and file.

    • TheZvi says:

      Thank you. I can see how the end might come across that way.

      I don’t think our views on how this works are so far apart; I certainly don’t think this applies only (or even mainly) to the rich. But our goals in reaction are somewhat different. Inm particular, consider it a noble and important (and practical!) goal to minimize the amount such networks are able to, or are motivated to, put their fingers on the dial in ways that don’t correspond to the best things.

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