When the crowd isn’t wise
IN the days leading up to the Supreme Court’s health care decision, rumors began to circulate in Washington that the justices had decided to uphold the law. Liberals around town who might have reason to know the outcome seemed happy, according to the gossip, and a couple of conservative justices had seemed angry when the court met three days before the announcement. On the eve of the ruling, a few respected court watchers went so far as to predict publicly that the law would be upheld.
It is impossible to know how much of the gossip sprang from actual information. Several dozen people — the justices, their clerks, other members of the court staff — did indeed know the outcome in advance. Although they have a record of discretion exceeding even that of some parts of the national security apparatus, they are human. They have friends and relatives, and they have emotions.
With the rumors swirling, I began to check the odds at Intrade, the online prediction market where people can bet on real-world events, several times a day. The odds had barely budged. They continued to show about a 75 percent chance that the law’s so-called mandate would be ruled unconstitutional, right up until the morning it was ruled constitutional.
The market — the wisdom of crowds — turned out to be wrong.
I have since come to think of the court’s ruling as the signature example of the counterattack of the insiders. After the better part of a decade in which various markets, from Intrade to the stock market, became many people’s preferred way to peer into the future, a backlash is clearly under way. Not so long ago, knowing about the existence of Intrade was a mark of being in the vanguard. Today, mocking Intrade, ideally on Twitter, is a sign of sophistication.
This development matters because predictions matter. They allow government officials, corporate executives and citizens to plan for the future. They are an unavoidable part of life.
The rise of prediction markets started in the middle of the last decade, brought about by a combination of politics, psychology and technology. The politics came mostly from the aftermath of the Iraq war, when the collective, pro-invasion opinion of Washington experts came to look tragically wrongheaded. The psychology came from a barrage of research, often called behavioral economics, that created a science of human foibles. People were systematically too confident, the research found. They put too much weight on information they liked and too little on data that contradicted their assumptions.
The only good alternative to a few flawed opinions, some researchers argued, was a vast number of flawed opinions. The biases often canceled one another out. The legitimate information rose to the surface. It was the wisdom of crowds, as the writer James Surowiecki called his 2004 book.
The Internet made collecting the wisdom of crowds vastly easier than before. Intrade, Betfair and other British and Irish betting sites became the public face of prediction markets. Google and other companies started their own internal prediction markets to help them make decisions about where to invest. The Pentagon planned one, to track threats, before deciding it did not like the image of American officials making bets about war and famine.
The early successes of prediction markets were notable. To take a small personal example, my wife and I, not exactly frequent moviegoers, twice won money in a large Oscars pool simply by hewing to the British odds. Much more significantly, Intrade was a more reliable guide to the 2006 midterm election than cable networks. On election night, its odds showed that the Democrats had become the favorites to retake the Senate, while television commentators were still telling viewers it was unlikely.
But the crowd was not everywhere wise. For one thing, many of the betting pools on Intrade and Betfair attract relatively few traders, in part because using them legally is cumbersome. (No, I do not know from experience.) The thinness of these markets can cause them to adjust too slowly to new information.
And there is this: If the circle of people who possess information is small enough — as with the selection of a vice president or pope or, arguably, a decision by the Supreme Court — the crowds may not have much wisdom to impart. “There is a class of markets that I think are basically pointless,” says Justin Wolfers, an economist whose research on prediction markets, much of it with Eric Zitzewitz of Dartmouth, has made him mostly a fan of them. “There is no widely available public information.”
These flaws have become fodder for the markets’ critics. On the day of the health care ruling, the widely read financial writers Barry Ritholtz, Felix Salmon and David Wessel all took to Twitter to point out that Intrade looked bad. Tony Fratto, a former aide to President George W. Bush, noted his “real glee” that “Intrade was wrong, again.”
But such schadenfreude raises a question: once you accept that prediction markets are flawed, do you turn back to the inside experts?
ALAS, the experts’ overall record remains as poor as the behavioral economists maintained — and often worse than the markets’ record. Mutual fund managers, as a class, lose their clients’ money because they do not outperform the market and charge fees for their mediocrity. Sports pundits have a dismal record of predicting games relative to the Las Vegas odds, which are just another market price. As imperfect as prediction markets are in forecasting elections, they have at least as good a recent record as polls. Or consider the housing bubble: both the market and most experts missed it.
The answer, I think, is to take the best of what both experts and markets have to offer, realizing that the combination of the two offers a better window onto the future than either alone. Markets are at their best when they can synthesize large amounts of disparate information, as on an election night. Experts are most useful when a system exists to identify the most truly knowledgeable — a system that often resembles a market.
Sometimes, this approach involves a wisdom-of-crowds approach to experts. My colleague Nate Silver, whose book on prediction comes out later this year, has found that a simple average of well-known economic forecasts is substantially more accurate than individual forecasts. Other times, the approach might involve as much art as science — and, again, the Internet allows for strategies that once would have been impossible.
Think for a moment about what a Twitter feed is: it’s a personalized market of experts (and friends), in which you can build your own focus group and listen to its collective analysis about the past, present and future. An RSS feed, in which you choose blogs to read, works similarly. You make decisions about which experts are worthy of your attention, based both on your own judgments about them and on other experts’ judgments.
Their predictions now face a market discipline that did not always exist before the Internet came along. “Experts exist,” as Mr. Wolfers says, “but they’re not necessarily the same as the guys on TV.”
After several years in which the market was often celebrated as a crystal ball, the Supreme Court ruling was a useful corrective. The prediction-market revolution, like so many others, initially promised more than it could deliver. But it’s not as if the old order was working particularly well.
David Leonhardt is the Washington bureau chief of The New York Times. Autor: David Leonhardt
Fuente: nyt
