America’s Best Pundit: Economix vs. Freakonomics
Economix, a blog run by The New York Times newsroom, is running a fun prediction contest ahead of tomorrow’s election. You have to pick three prediction-market stocks, and the winner is the person with the most profitable portfolio. You can enter here and read more here.
Economix is running this contest partly because David Leonhardt is interested in figuring out whether his readers are smarter than the InTrade prediction market.
Let me offer Leonhardt a friendly Economix vs. Freakonomics bet. I’m willing to bet him the market is smarter than the average Economix contestant. Let’s make the terms a good bottle of wine (plus boasting rights). Do we have a bet?
As usual, my reasoning is all about incentives. Let me explain. If I were trying to choose the three stocks on InTrade that would maximize my expected return, I would pick:
1. Winner: Obama (earning me a 20 percent profit)
4. McCain to earn fewer than 300 electoral votes (earning a 10 percent profit)
11. Obama to win Pennsylvania (earning a 20 percent profit)
But there’s only one prize in this contest, and so even if my picks are exactly correct, my portfolio will yield a “mere” 17 percent return. This is pretty good for a 24-hour period, but it’s unlikely to be enough to win first prize. And so I have a pretty strong incentive to bet on some longshots and hope that I get lucky. In fact, the stocks I picked were:
5. Bob Barr to earn 1 percent or more of the popular vote (for a 300 percent profit)
7. Obama to win Georgia (also a 300 percent profit)
18. Sen. Sununu (R-N.H.) to win re-election (for a 490 percent profit)
Here’s why InTrade will beat the average contestant: the “winner takes all” nature of the Economix contest pushed me to pick longshots, but as I wrote last week, longshots are typically overbet, yielding a negative return. And I think most entrants will follow a similar pattern, leading most of us to pick dud stocks, even if a small minority may get lucky on the longshots.
It’s an interesting irony that I’m betting on InTrade to beat the Economix readers, but my reasoning is not based on the view that prediction markets are fully efficient (they aren’t). Rather, my logic is that the nonlinear incentive in a tournament will act so as to amplify the market’s inefficiencies.
And perhaps this is a parable for our current financial mess, too.