Journey Through Prediction Markets

Will there be a vaccine to COVID? Will Trump be reelected? Would Iraq have weapons of mass destruction? Uncertainty. The invisible yet central character in all real world stories. People deal with uncertainty in different ways. Some “mitigate” uncertainty by just declaring, “Definitely!” Confidence is sometimes self-fulfilling and has a place. However, overconfidence can lead to misguided wars.

Another family of answers, can be summarized as “Maybe”. This isn’t wrong, but that’s not a virtue. “Not even wrong” is a famous scientific insult hurled at the vague. Is there a way to make forecasts with the precise meaning of “definitely” (100%) or “impossible” (0%), but without the evasive slipperiness of “a good chance” or “a distinct possibility”?

Prediction markets are a possible answer. Prediction markets, like PredicIt,  require people to implicitly put precise probabilities on events. They wager money for personal profit. Collectively this produces very specific forecasts (eg 74%). These forecasts are likely to be usefully accurate with some caveats (paper). The reason prediction markets get legal clearance is because academics are studying them. 

Wandering

For the last few months, I’ve researched and become fascinated by prediction markets. How and why do they work? When do they fail? What is trading on them like? How do you evaluate whether “74%” is a good forecast?

From scientific papers to blog posts, there’s a lot to read and explore. There is also a lot to experiment with. An overwhelming amount, in fact. I need a way to navigate and organize my desire to learn.

An Instrumental Goal

They say, “it’s the journey, not the destination”. Outside of airlines, that may be true. However, journeys are still organized and defined by their destinations. As a person who enjoys dabbling and wandering, sometimes I still find destination-type goals are a helpful tool for ensuring the journey is what I wanted.

To organize my wandering into a journey, I’m setting an instrumental goal (a destination). My primary objective is learning and my secondary objective is determining if prediction markets could offer a longer term, passive(ish) investment opportunity.

To explore both, my instrumental goal is investing a fixed amount on PredictIt for a year and assessing:

  • Can I clear an annualized return higher than my alternatives? (target: 10%+ net of all fees) [1]
  • Can I find a repeatable strategy with a good return on time? [2]
  • Is this fun / am I learning or is this purely becoming a transaction?

Topics I hope to learn about: statistical methods to assess forecast calibration, market dynamics (order books and arbitrage), complex project management and investment strategy development / backtesting.

My year will end around October 9, 2020 (this post is belated). In the meantime, I may share some lessons learned along the way!

_____________________________________________________

[1] Goal is beating long term average returns of equities (6-8%) since an index fund is the alternative. Before the 5% withdrawal fee, I’m targeting a 15%+ return.  
[2] Attractive strategies on a % return basis may not scale well due to capital limits (max $850 per contract). With automated trading banned, I’ll eventually need a large enough $ return on my time if I continue investing beyond this year.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: