prior probability

I linked to Nick Whitaker and J. Zachary Mazlish’s powerful critique of existing prediction markets (“Why prediction markets aren’t popular“; see above) in one of my previous posts (see here), where I also promised that I would respond to their points, so here it goes:

I must, however, begin with a confession. Although I read Whitaker and Mazlish’s words over a month ago (their excellent piece was published on 17 May 2024), it has taken me over a month to reply in large part because their critique of prediction markets is a devastating one. For starters, they pre-empt prediction market defenders like yours truly by first exploring the legal environment of prediction markets. Although a few well-defined betting categories are illegal (e.g. assassinations, elections, etc.), Whitaker and Mazlish conclude that “prediction markets are, in large part, legal …” In other words, prediction markets have failed to attract investors not because of regulatory impediments or other “legal failures” but for other reasons.

So, what are these reasons? Here, Whitaker and Mazlish’s deliver a mortal one-two-three combination knockout punch. In summary, they first identify the three types of investors or traders that prediction markets must appeal to in order to succeed: (1) cautious or risk-averse “savers”, i.e. long-term investors; (2) thrill-seeking, risk-loving “gamblers”, i.e. dumb-money day-traders or short-term investors; and (3) “sharps” or professional investors. And then they explain in so many words why prediction markets do not appeal to any of these groups of traders:

1. Savers: For starters, prediction markets don’t appeal to “savers” because such markets are zero-sum: “Every winner of a prediction market necessitates an equal and opposite loser”. Most “savers”, by contrast, prefer low-risk portfolios that are expected to generate positive returns over long time horizons.
2. Gamblers: Next, prediction markets don’t appeal to “gamblers” because most prediction markets take too long to resolve: “for gamblers, quick resolutions are one of the key things that make a bet attractive and exciting”. In other word, “gamblers” mostly prefer quick action, i.e. bets with fast payouts, the same day they are made.
3. Sharps: Last but not least, prediction markets don’t appeal to “sharps” because of the lack of dumb-money gamblers and liquidity-providing savers. Without these first two groups of traders, sharps are left with little incentive to join the fray, or in the eloquent words of Whitaker and Mazlish:

As most prediction markets also lack many of the features that attract gamblers, whom sharps would prefer to trade against, sharps are left with the unappealing prospect of trading only with one another. This is analogous to turning up to a poker table and discovering that all of the other competitors are poker champions. You would much rather have been at a table of drunk tourists.

But what if we could somehow attract high-risk gamblers and low-risk savers? As it happens, my colleague and friend Steve Kuhn is creating a new type of information market that many gamblers — and maybe even some savers — might find attractive. Why? Because Kuhn solves most, if not all, of the problems identified by Whitaker and Mazlish! Stay tuned, I will describe Kuhn’s ingenious proposal in my next post.

Despite the unceasing and unfathomable efforts of Elon Musk to destroy the Twitter platform (see here, for example), I am still often able to find little eclectic gems like this thread:

Shout out to my colleague, friend, neighbor, and mentor Tony Suarez for inviting me to join his popular “I need to know” podcast last week. Among other things, we discuss the valuation of business firms, the dramatic decline in Puerto Rico’s population, and my latest textbook.

My wife Sydjia and I heard this beautiful ballad for the first time last weekend at Azay, a cozy restaurant in the Little Tokyo neighborhood of polyglot Los Angeles. I dedicate this song to her.

On this day (20 June) in 1789, deputies of the “Third Estate” of the Estates-General (see here and here) met at the Royal Tennis Court in the Palace of Versailles, where they made “a solemn oath never to separate … until [a new] constitution of the realm is established and fixed upon solid foundations”, i.e. until they had drafted a written constitution limiting the absolute powers of the king. (For more details about this historic moment, see here and here.) This pivotal episode in the French Revolution was later immortalized by the great Jacques-Louis David in his unfinished fresco The Tennis Court Oath (pictured below), an epic symbolic work that merits its own separate blog post. In the meantime, see here.

Celebrate freedom! Today (19 June) is officially “Juneteenth National Independence Day” in the U.S.: https://en.wikipedia.org/wiki/Juneteenth. Bonus track below:

Update: alas, when my daughter and I visited the mall today (Americana at Brand), all the stores but one (Nike) were open for business.

For some unknown algorithmic reason, a strange essay published in The Atlantic in 2022 kept popping up in my Twitter feed this weekend. This obscure essay, which is titled “Why do rich people love quiet?“, immediately brought back memories of my torts professor and mentor Guido Calabresi, who changed my intellectual life forever. Among other things, Guido — to this day, he prefers to be called by his Christian name — introduced me to the works of Ronald Coase and taught me a disturbing Coasean/Calabresian insight: most conflicts, including disputes about noise, are almost always “reciprocal” problems, i.e. both the “victim” and “wrongdoer” are often jointly responsible for whatever harm has befallen one of the parties. To this end, I can still remember one of the cases Guido assigned, Sturges v. Bridgman or what I now call “the case of the noisy confectioner”, and his unorthodox discussion of the reciprocal conflict between the silence-loving doctor and noise-making confectioner in that classic case. More generally, Guido asked us, what legal or moral rights should men of contemplation (like the doctor in Sturges v. Bridgman) have vis-a-vis “doers” or men of action (like the noisy confectioner)?