Posted by: Paul Hewitt | June 19, 2012

Good Judgment Project Round 2

Well, the Good Judgment Project has started up for the second season.  Again, we will be predicting events around the world.  Last year, my group used a modified prediction market.  It was a bit unusual, because you could rescind earlier predictions and lose nothing.  In my opinion, this created powerful incentives for seeking out risk.  Not exactly what one would hope for when making predictions about the future.  Still, the Good Judgment Project had the most “accurate” predictions among the five groups taking part in the IARPA contest.

This year, we have a true prediction market.  Our group uses a continuous double auction market mechanism to effect trades.  There is no automated market maker, like we had last year.

Generic Problem, Creative Solution

One problem with any prediction market concerns the setting of the initial likelihood of the event taking place.  Ideally, we want to set the likelihood equal to the current best estimate (from whatever sources are available).  That way, there are no windfall gains to be made by those that place the earliest trades.

For example, in a binary contract, if the likelihood of the event occurring is not 50%, based on current knowledge, but the market is set up at 50%, the first trader has the opportunity to make greater than normal profits from very little new information.  In these markets, events to be predicted are released in batches.  An early bird will pick up a lot of free worms.  Over the course of the prediction season, this early bird will acquire significantly more “wealth” than will the late-risers.  Unfortunately, the early bird will be able to have greater influence on future market prices, despite the fact that he or she doesn’t really know much more than the late-risers.

The designers of the Good Judgment Project prediction markets found a novel way of setting the initial likelihoods.  Rather than set a market price for each contract, they set up open bids and asks around the initial likelihood.  In order to make a purchase, at the outset, you have to match the lowest asking price.  Similarly, to make a short sale, you have to match the highest bid.  Of course, you can make your buy or sell order at any price and wait, hopefully, for the market to move in your direction.

Rather interestingly, these markets are designed to generate automatic bids and asks, depending on the price movements in the market.  Let’s say a trade moves the price of a contract from $0.40 to $0.45.  The market will automatically generate a new ask at $0.50 and a new bid at $0.40, unless there is already a bid or ask at that price.  This modifying mechanism creates liquidity, but just a little bit.  Each of these automatic bids and asks is for one share only.

Whether this was intended or not, it does allow one trader to quickly move the market (or manipulate it?) with a small investment.  By successively purchasing (or selling) contracts (one at a time), you can move the market a fair bit with a few trades.  Of course, other traders can bring the market price back, if it is not considered to be “accurate”.

Liquidity

Here, I’m talking about a different kind of liquidity.  There are quite a few markets available for trading, some carried over from last year’s session.  This year, we have been given $100 to trade, which isn’t a lot, but considering that all contracts are less an $1.00, it should be sufficient.  Unfortunately, as you trade, you create a portfolio of contracts and ultimately very little cash.  When new contracts are introduced, we will have to make decisions to get out of existing contracts, if possible, so that we can invest in some of the new ones, which may offer a better return on investment.

Judging by the first couple of days of trading, it isn’t always easy to get out of a position, if the market has moved significantly since the original purchase (or sale).  There will be times when I have to sell off a loss, in order to have funds to invest in a more lucrative contract.  Not only that, I may wish to do so before the new contracts are released, so I will be able to get in early.

How am I doing, you ask?

At this point, on day 2, I’m leading our group with $128.01, with the next closest at $119.42.  This could all change in the next hour, but at least I got an early start to trading this year, and it is reflected in my relatively high “wealth”.  Last year, I didn’t get into the market for a couple of weeks, and as a result I was never able to catch up to the early birds!

One other thing.  It is much more time-consuming to follow the markets and decide upon bids than it was to make simple trades last year!  By the time this is all said and done, I’m sure I will have earned about a penny an hour for my efforts!  Oh well, it’s for a good cause…enlightenment.

I’ll keep you informed from time to time.

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