Those who have followed our various examples of the Dumb Agent Theory, efficient markets, and in particular how prediction markets are successful at predicting, might have a nagging doubt about manipulation. How easy is it really for someone, or a group of people, to manipulate prices?

A paper by David Rothschild and Justin Wolfers points out recent odd activity in Intrade, a political prediction market, following the US presidential nominee debates. They point out how it seems a group of traders chose low volume time periods to push Mccain contracts higher:

The biggest difference between typical market movements and manipulation is that honest traders will usually try to minimize the impact of their trades on the market price — paying higher prices for an asset only cuts into profits. But a market manipulator, intent on buoying the market’s ratings of their preferred candidate, will work to maximize the impact of their trading on the price.

They conclude, however, that even if these were manipulations, they were corrected fairly quickly and it seems as though no one was able to make money off them. It can still be troubling, however, but it is not the first time this has occurred.

Paul W. Rhode and Koleman S. Strumpf wrote a more general paper on the manipulation of prediction markets; from the first political one on Wall Street (1880-1944) to the Tradesports.com incident in 2004 when one trader tried to manipulate prices. While the paper is highly recommended, we will limit ourselves to pointing out that they also conclude that manipulations, when they do occur, tend to be very short-lived and are almost never profitable for those who try to manipulate.

When examining prediction markets, as with any market, you should always look at volume. As long as there are enough people trading it can act as a legitimate platform and manipulation, while always possible, will likely have little or no effect in the long term. We also believe that prediction markets, like Democracy, are far from perfect, but they are the best form of an indicator we have thus far.

Link to 2008 election market manipulation paper: Market Manipulation Muddies Election Outlook

Link to Prediction Market Manipulation paper: Manipulating Political Stock Markets: A Field Experiment and a Century of Observational Data