Market Makers & Prediction Markets

A while ago I posted on the idea of futarchy and followed up with a post on implementation and issues of virtual stock markets.

I only posted links on auction markets, i.e. where one party makes an offer, another one a request and the system finds a match. That only works good for systems with high liquidity. Especially on prediction markets with combinatorical outcomes (e.g. of the form "if person A becomes the candidate for party 1, then party 2 will win the election" or even more complex constructions) this is difficult: you need to find people making similar opposite bets to match. A way around of this is to use a market maker instead of an auctioneer. It takes the trades directly instead of leading a negotiation between to parties. The price is set automatically by the system. This, of course, also has drawbacks. In a real life system, the market maker provides liquidity and thus is at risk losing some money. Moreover, the pricing of the goods depends on parameters of the market maker. Wrong values for thick or thin (i.e. markets with many/few participants) might make the price either bounce up and down or move only tiny bits.

• On combinatorial prediction markets
• an aricle on implementing a simple market maker
• article on books and market makers
• Multi-Outcome markets

On (implementation issues of) Virtual Stock Markets

After my recent post on prediction markets, I decided to implement a small auctioneer for virtual stock markets with two parties making deals, i.e. not a market maker mechanism but a (traditional) double auction. But, despite the simple idea behind a bid/ask driven market, the implementation has to take into account quite a number of details: can you buy/sell one unit or multiple units of a good at a time? Does trading occur at discrete events or is it continuous? Is pricing uniform (all trade at the same equilibirum price) or discriminatory (individual matching of bid/ask orders)? And, if one the two options is chosen, how is the price determined?

• Beside the double auction system, bidding can take other forms: Auctions and Bidding: A Guide for Computer Scientists
• Everything you wanted to know about double auctions, but were afraid to (bid or) ask
• And finally a paper on two multi unit k-double auction algorithms

Futarchy: applying prediction markets

R. Hanson suggests to use prediction markets to make better use of information to evaluate strategies in politics. He calls the combination of democracy and speculative market information processing futarchy. There is a short manifesto and a full paper (PDF).

The central idea is: Use democracy to express what you want, use prediction markets to evaluate how to reach these goals. People can give strategies which are traded after paying a small fee; when they seem to be efficient the get a payback, otherwise they loose the fee. Thus good strategies are rewarded, bad ones are not rewarded but cost an extra fee. Augmented GDP and other indicators give a measured value to the state of the country.

Resources on Prediction Markets

Prediction Markets might be useful in modern politics - gathering crowd information (expected outcomes) and filtering experts from the crowd (i.e. successful traders in the market).

Just a bunch of links to read on the matter:

• Prediction Markets im Journal of Economic Perspectives.
• Combinatorial Prediction Markets at oddhead blog. Overview about types of combinatorial markets and the problems with handling them
• Betting on Ideas in Communications of the ACM
• Internet-Based Virtual Stock Markets for Business Forecasting

Some Commentaries on Politics

Project Syndicate features some interesting articles and commentaries about politics.

Project Syndicate: the world's pre-eminent source of original op-ed commentaries. A unique collaboration of distinguished opinion makers from every corner of the globe, Project Syndicate provides incisive perspectives on our changing world by those who are shaping its politics, economics, science, and culture. Exclusive, trenchant, unparalleled in scope and depth: Project Syndicate is truly A World of Ideas.

It includes authors like Ban Ki-moon, Christine Lagarde, Javier Solana, Dominique Strauss-Kahn, Martin Feldstein, Otmar Issing, Peter Singer and many more.

The Rise of the Creative Class

I purchased a new book, The Rise of the Creative Class: And How It's Transforming Work, Leisure, Community and Everyday Life by Richard Florida.

According to this book, the creative class consists of those people who primarily create, combine, modify and extend ideas. This includes artists and musicians, but also ranges to scientists and engineers even some managers are included. Taking a look at the class and its composition, Florida argues how companies and countries can react to the growing importance and influence of creative workers. It turns out that there is a strong correlation between places with many gays, artists, cultural/ethic mixture and a strong creative industry/economy.
Furthermore he argues that people tend to cluster at places they like rather than to prefer places the industry chooses to build their factories. Consequently cities and counties should take measures to ensure those people will cluster.

Reading it (and not having finished it yet) I get the feeling that all that needs to be done is to follow the arguments M. Friedman made: let the free market decide. Deregulation should allow people to cluster whereever they like to and due to democratic systems form their environment according to their likings. The creative class contains up to one third of all employees - being not a minority at all, special rules, laws and regulations can be supported by the class itself if necessary. With respect to the backward, conservative US laws, the abolishment of quite some laws seems to be the better alternative.