The gamble of downplaying manipulation
That prediction markets may be manipulated with some persistence should be no surprise to anyone who has followed the subject in the past couple of years. Here is a sampling of some of the warnings:
The HRC attack, part 2
Manipulation can affect prices.
Is there manipulation in the Hillary Clinton Intrade market?
Is there manipulation in the Hillary Clinton Intrade market? Redux
Measured Enthusiasm For Prediction Markets
We now even find some academic papers that admit that manipulative trading may be profitable given certain assumptions. It is up to readers to decide which papers contain the most "stylized" assumptions.
No-one argues whether, in the long run, in general, manipulation is a losing proposition that subsidizes other traders — but is it really prudent to deploy that message, in comments to CFTC for example?
First, if Obama wins the election, based on the other available markets and poll projections, it would seem that an error had been introduced into the largest and most widely-cited of prediction markets. When comparing market and poll accuracy over time we are usually talking about only a few percentage points difference, so this error isn't trivial. Furthermore this is a market that takes place only once every four years, so long-run arguments ring a little false. There's no reason why something similar couldn't happen in 2012. At least, one is optimistic that the regulatory situation will improve and Intrade's traders will be more numerous and less capital-constrained at that time, which should make manipulation more difficult on average. Those who downplay the dangers of manipulation risk such goals by sacrificing their general credibility. It's a negative skew proposition.
Second, some markets can irreversibly affect the outcome they predict. This happens infrequently and requires some fundamental basis, but specific cases can spectacularly undermine a general argument. This is the old bit about trying to cross a river that's three feet deep on average. An example we've seen recently: when a business is predicated on maintaining a deposit base or borrowing short-term at certain rates, manipulation might be irreversible if it targets confidence or attacks the business's funding costs. In essence, the manipulator forces the (possibly quite liquid) market to "settle" as the firm approaches insolvency, and prices do not snap back. Breaking a currency peg has a similar dynamic. Now, there is currently no real analog to these situations in prediction markets as such, but either these markets will continue to be relatively small and not widely-followed, or ....
Kenneth Arrow and Intrade CEO John Delaney are making the right arguments here: transparency in the form of more public markets, along with less concentrated risk, would have helped avoid this crisis. But don't try to sweep uncomfortable subjects under the rug. That won't end well.