Tuesday, September 18, 2007

Iraq and prediction markets

So having read through the Greenstone article, he does put some caveats around the use of Iraq government bonds as a predictor of the success or failure of the surge. Most notably, he admits that the market reacts to the same information we all have - making it, in my opinion, vulnerable to the same errors and biases. Of course, he argues it's the size of the market and the more rational opinions that make it better at predicting the outcome. More 'rational' as traders are only interested in the future income stream from the bonds, they have no other vested interest one way or another in the outcome.

All things being equal, I would rather place my bets on the collective wisdom of bond traders than any of the opinions on Iraq coming out of the US government - I think that is a given. I would also trust the traders more than, say, a poll of American citizens - most don't understand the war and just parrot back the media spin.

But I still wouldn't put a lot of money down. Why? Because the situation in Iraq is too dependent on Black Swans - the name Taleb gives to highly unpredictable but game changing events. A single incident (the bombing of a holy shrine, the murder of a political figure, a massacre, etc) can turn the course of the war. These incidents are hard to predict. No amount of public information helps. No amount of rational, unbiased assessment helps.

Because of this, the nature of the problem in Iraq is, in my opinion, ill suited to a prediction market. The prediction might be less biased, but it's not necessarily any more accurate.

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