Tuesday, July 22, 2008

Buy! Sell! #1: Prediction Markets Intro

Back in the Nineties while we were still undergrad pimple-poppers, I came to know a coke-laced gambling-addicted, insomniac who traded junk bonds at night while the rest of us studied, drank, and slept. Then there was my roommate who bounced back and forth between joining the Freemen, the FBI, and the Kosovo Jihad.

Who am I kidding ... it was NYU ... everyone was popping pills. But I digress.

The 3 of us could hardly come from more different backgrounds and had our own wacky ideas but had remarkably arrived at the same spot (philosophically, geographically, and temporally) on many levels. I've always appreciated the reassurance of their conviction, even when we were all leaning against a heady wind. Not immaterially, we all shared a deep and long-standing respect for Reagan.

It was the insomniac who first introduced me to prediction markets. What started as a nighttime obsession became a side job became a career, but from day one he never could leave work at the office. Between the office elevator and the subway station he'd be on his cell placing bets on anything and everything that the future might hold. Watching sports with these guys was mentally exhausting. With every point or foul, there was a flurry of cell phones as they all speed-dialled their brokers with a new futures order. Ten thousand at niner and an eighth on Shaq to drink water instead of Gatorade in the fourth! Hedge that with a short on Schumacher to pit before lap 30 at seventy-five spot naught! Rah! Lift that offer you cocksucker! How's the wife? Did she recover from last night yet? Remind me to buy you a drink next time we're in Vegas!

As is the tragedy of evolution, humans hardly even make trading decisions anymore (thanks a mil, modellers!), much less have a broker on speed dial for such interaction. Going going gone the way of the Yellow River dolphin and the open-outcry pits.

I don't think these guys knew that the academics had not fully conceptualized prediction markets yet. I know they didn't give a rat's ass. But intellectualized it was; then automated; then commercialized; then specialized. Corporations (especially HP and GE) started to steal the idea to help them in their sales prediction, as well as new product and marketing campaign creation. Who needs employees at all anymore? But I digress.

Now come vanity markets such as Bet2Give where you put real money in, but any winnings are automatically donated to charity. This conveniently avoids the legality question of betting on the future. As their FAQ says If you bet wrong and lose, your money will still go to worthy causes... but chosen by others. Hmm... I wonder if I can place a bet on how long it'll take the IRS to figure all this out?

Will bets on future events become an asset class in the same way bets on future cash streams or future prices have?

So I'm in. I'll be trading the future and reporting back on my riches ... all of which will be routed to the Ronald Reagan Presidential Foundation for this first round.

There's a twist. Prediction markets are still young, and as such, they're very thin. Not a lot of activity, and not a lot of options available to reflect the nuances or breadth of one's comprehensive view of the future ... aka one's portfolio (of bets on future events) in market lingo. As such, I'll be publishing several "model portfolios" here from time to time under the "Buy!/Sell!" series title.

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