Smarter Markets: Bringing Intelligence into the Exchange

Example: Smarter Prediction Markets

David PennockMicrosoft Research

NYSE 1926

http://online.wsj.com/article/SB10001424052748704858404576134372454343538.html

NYSE 1987

http://online.wsj.com/article/SB10001424052748704858404576134372454343538.html

NYSE 2006-2011

•2011 Deutsche Börse AG

•2007 Euronext

•2006 Archipelago, ipo

NYSE 7pm Sep 10, 2012

New Markets – Same CDA

2012 September 10 7:23 p.m. ET

2012 September 10 7:23 p.m. ET

Between 3.0% and 3.7% chance

http://www.predictwise.com/maps/2012president

Design for Prediction

• Goals for trade– Efficiency (gains)– Inidiv. rationality– Budget balance– Revenue– Comp. complexity

• Equilibrium– General, Nash, ...

Design for Prediction

• Goals for trade– Efficiency (gains)– Inidiv. rationality– Budget balance– Revenue– Comp. complexity

• Equilibrium– General, Nash, ...

• Goals for prediction– Info aggregation– 1. Liquidity– 2. Expressiveness– Bounded budget– Indiv. rationality– Comp. complexity

• Equilibrium– Rational expectations

Competes with:experts, scoring rules, opinion pools, ML/stats, polls, Delphi

Design for Prediction

• Goals for trade– Efficiency (gains)– Inidiv. rationality– Budget balance– Revenue– Comp. complexity

• Equilibrium– General, Nash, ...

• Goals for prediction– Info aggregation– 1. Liquidity– 2. Expressiveness– Bounded budget– Indiv. rationality– Comp. complexity

• Equilibrium– Rational expectations

Competes with:experts, scoring rules, opinion pools, ML/stats, polls, Delphi

Why Liquidity?

Why Liquidity?

Low liquidity takes the prediction out of marketshttp://blog.oddhead.com/2010/07/08/why-automated-market-makers/

Between 0.2% and 99.8% chance

Why Expressiveness?

Why Expressiveness?

Why Expressiveness?

Why Expressiveness?

• Call option and put options are redundant• Range bets require four trades

(“butterfly spread”)• Bid to buy call option @strike 15 can’t match

with ask to sell @strike 10• Can’t set own strike• Bottom line: Lacks expressiveness

Why Expressiveness?

• Dem Pres, Dem Senate, Dem HouseDem Pres, Dem Senate, GOP HouseDem Pres, GOP Senate, Dem HouseDem Pres, GOP Senate, GOP House...

• Dem PresDem HouseDem wins >=270 electoral votesDem wins >=280 electoral votes...

Industry Standard

• Ignore relationships:Treat them as independent markets

• Las Vegas sports bettingKentucky horseracingWall Street stock optionsHigh Street spread betting

A Better Way(Or,... Bringing trading into digital age)

• Expressiveness– Linear programming– Bossaerts, Fine, Ledyard: Combined Value Trading– http://bit.ly/multipm

• Expressiveness + Liquidity– Automated market maker– Always quote a price on anything– Downside: requires subsidy/risk

Example: Liquidityand Expressiveness

Getting Greedy

• Design a marketfor information on exponentially many things

• “Combinatorial prediction market”

Combinatorial securities:More information, more fun

• Payoff is function of common variables,e.g. 50 states elect Dem or Rep

Combinatorial securities:More information, more fun

• Dem will win California

Combinatorial securities:More information, more fun

• Dem will lose FL but win election• Dem will win >8 of 10 Northeastern states• Same party will win OH & PA

OH

PA

Combinatorial securities:More information, more fun

• There will be a path of blue from Canada to Mexico

OR

WA

Some Counting

• 54 “states”: 48 + DC + Maine (2), Nebraska (3)• 254 = 18 quadrillion possible outcomes• 2254 1018008915383333500 distinct predictions

More than a googol, less than a googolplex• NOT independent

A tractable combinatorial market maker using constraint generation

ACM EC 2012

MIROSLAV DUDÍK,SEBASTIEN LAHAIE,DAVID M. PENNOCK

Thanks: David Rothschild, Dan Osherson, Arvid Wang, Jake Abernethy, Rafael Frongillo, Rob Schapire

http://PredictWise.com/fantasy

Predictalot alpha

Combo Prediction Markets:More Info

Gory detailsWhat is (and what good is) a combinatorial prediction market?

http://bit.ly/combopm

More accessibleGuest post on Freakonomics

http://bit.ly/combopmfreak