Failures of InTrade to accurately estimate probabilities are frequent. The reasons are obvious, but perhaps unappreciated by market-worshippers. Some of those reasons lead to inefficiencies…which could be exploited.
InTrade uses group betting behavior to come up with a wisdom-of-crowds estimate of various probabilities: sporting event outcomes, political races, and all kinds of events. Recently the market completely failed to predict SCOTUS Chief Justice John Roberts’s ACA ruling. This example reveals one big reason for market failure: when bettors lack relevant expertise and/or information. In this case, a reasonable probability for upholding the ACA might have been drawn from Constituional law scholars: 8/21 = 38%.
Even when lots of data are available, such as political polls, InTrade can still fail. One simple reason is bias: InTrade bettors appear to skew Republican. This could explain why there is such a mismatch between the poll-based Obama win probability (>99% for an election today, probably >80% in November) and the InTrade price (equivalent to a probability of about 0.56). This could be excused on the grounds that the election is far off, and there is uncertainty as to what will happen in the next 4 months. However, there is a third flaw.
As I’ve written before, InTrade bettors are habitually underconfident in the face of polling data, even on the eve of an election. Even a 10-point lead in a race is insufficient to drive a market-based probability estimate above 80%. This is perplexing since such a lead is basically a sure thing.
I am currently analyzing some of the biggest weaknesses. A second point is how to allocate resources. For that the Kelly criterion seems to be useful.