Finance Celebrated, Ignored
There is no way to predict the price of stocks and bonds over the next few days or weeks. But it is quite possible to foresee the broad course of these prices over longer periods, such as the next three to five years. These findings, which might seem both surprising and contradictory, were made and analyzed by this year’s [Economics Nobel] Laureates, Eugene Fama, Lars Peter Hansen and Robert Shiller. (more)
Today news outlets of all sorts will report on this year’s Nobel prize in economics, which goes to three giants of finance. There will be lots of commentary on subtle results in finance and what they mean for stock returns and financial crises. But one thing you might not notice in all that commentary is a simple fact that seems too obvious and widely accepted among finance experts and the Nobel committee to be worth mentioning: speculative markets generally do an excellent job of aggregating information.
Among the many theories still debated to explain the wide variety of odd patterns in market prices, virtually none of them have much to do with speculators failing to act on cheaply available information. Why? Because so many folks in finance have long tried and failed to find satisfactory explanations along those lines, and have basically given up. This isn’t to say that we never see price errors after the fact, along with previously available info not very well considered. (See this nice example.) The point is that there are few interesting or consistent pattern of such things; mostly speculators just make excusable mistakes about what info to consider.
Yet even though this simple fact seems too obvious for finance experts to mention, the vast majority of the rest of news coverage and commentary on all other subjects today, and pretty much every day, will act as if they disagreed. Folks will discuss and debate and disagree on other subjects, and talk as if the best way for most of us to form accurate opinions on such subjects is to listen to arguments and commentary offered by various pundits and experts and then decide who and what we each believe. Yes this is the way our ancestors did it, and yes this is how we deal with disagreements in our personal lives, and yes this was usually the best method.
But by now we should know very well that we would get more accurate estimates more cheaply on most widely discussed issues of fact by creating (and legalizing), and if need be subsidizing, speculative betting markets on such topics. This isn’t just vague speculation, this is based on very well established results in finance, results too obvious to seem worth mentioning when experts discuss finance. Yet somehow the world of media continues to act is if it doesn’t know. Or perhaps it doesn’t care; punditry just isn’t about accuracy.
Even these Nobel prize winners, now that they have the attention of the world for a few days, won’t bother to mention how we could use finance to effectively answer most of the non-finance questions we commonly debate. These academic finance experts won’t even think to discuss how the academic finance community itself could use speculative markets to create and disseminate accurate estimates on important disputes in academic finance. Is that because they don’t notice, or don’t care, or what?
"The idea is that when the information isn't feasible to compute, then markets come into their own. The market accomplishes an aggregation no individual computing agent could--exactly because the information is so complex and dispersed."
That only works for existing financial markets because the participants each know a different piece of the puzzle: their personal preferred price and personal flexibility (the market solves a communication problem), plus the market is a self-fulfilling prophecy machine. With prediction markets you lose those properties (the event can completely ignore the prediction market and rather than having unique and sufficient pieces of the puzzle the participants all hold similar or even the same piece, because they'll rely on a handful of complicated calculation models, and even if they had unique pieces there would be no guarantee they were sufficient), the dynamics are just fundamentally different. I don't quite know why Robin Hanson doesn't see that.
"If it isn't available to anyone, then prediction markets (if they correctly combine the available information) will do better than anyother method of prediction."
The least worst option can still be so bad it's not worth it (and this is to be expected for most interesting events you'd want to predict) and as you say these prediction markets come with a cost.
No, reliability (or accuracy if you prefer) may still be very low because the information required for good predictions is not available to the investors (inside information is required or it's really complicated or not even feasible to compute).
The idea is that when the information isn't feasible to compute, then markets come into their own. The market accomplishes an aggregation no individual computing agent could--exactly because the information is so complex and dispersed.
If there's information that's not available to investors, then either it's available to other people or not. Only in the former case is it a potential argument against prediction markets. If it isn't available to anyone, then prediction markets (if they correctly combine the available information) will do better than any other method of prediction. And that's the only relevant question (besides how much do the methods cost to implement, which is the big question that Robin tends to avoid).
[Added.] But there's one important reason prediction markets make information less available than it would be without prediction markets. This does require consideration I haven't seen it given: Prediction markets will foster hoarding information that would otherwise be public. (Thus, there is conflict between prediction markets and public argument and discussion.)