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Unnamed comments on Open Thread: July 2010, Part 2 - Less Wrong
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I have a question about prediction markets. I expect that it has a standard answer.
It seems like the existence of casinos presents a kind of problem for prediction markets. Casinos are a sort of prediction market where people go to try to cash out on their ability to predict which card will be drawn, or where the ball will land on a roulette wheel. They are enticed to bet when the casino sets the odds at certain levels. But casinos reliably make money, so people are reliably wrong when they try to make these predictions.
Casinos don't invalidate prediction markets, but casinos do seem to show that prediction markets will be predictably inefficient in some way. How is this fact dealt with in futarchy proposals?
One way to think of it is that decisions to gamble are based on both information and an error term which reflects things like irrationality or just the fact that people enjoy gambling. Prediction markets are designed to get rid of the error and have prices reflect the information: errors cancel out as people who err in opposite directions bet on opposite sides, and errors in one direction create +EV opportunities which attract savvy, informed gamblers to bet on the other side. But casinos are designed to drive gambling based solely on the error term - people are betting on events that are inherently unpredictable (so they have little or no useful information) against the house at fixed prices, not against each other (so the errors don't cancel out), and the prices are set so that bets are -EV for everyone regardless of how many errors other people make (so there aren't incentives for savvy informed people to come wager).
Sports gambling is structured more similarly to prediction markets - people can bet on both sides, and it's possible for a smart gambler to have relevant information and to profit from it, if the lines aren't set properly - and sports betting lines tend to be pretty accurate.
I have also heard of at least one professional gambler who makes his living by identifying and confronting other peoples' superstitious gambling strategies. For example, if someone claims that 30 hasn't come up in a while, and thus is 'due,' he would make a separate bet with them (to which the house is not a party), claiming simply that they're wrong.
Often, this is an even-money bet which he has upwards of a 97% chance of winning; when he loses, the relatively small payoff to the other party is supplemented by both the warm fuzzies associated with rampant confirmation bias, and the status kick from defeating a professional gambler in single combat.