Contract Types on iPredict

When I talk to people about iPredict, I think many come away with the idea that the only kind of contract on iPredict is all-or-nothing contracts that either pay $1 or $0.

There are three kinds of contracts that can be run on iPredict, two of which currently appear on iPredict, and one we'd like to develop and add to the site soon.

The contract types are:

# Binary: these are the yes/no questions that either pay $1 or $0. The interpretation of binary contract prices is as "likelihoods" e.g. $0.51 = 51% chance of being judged true.

# Indexed: these contracts have their payout tied to an observable variable such as inflation or vote share or sales revenue. For example, iPredict is running INFL.3Q08. This contract pays 1 cent for each 0.1% of inflation that is reported for New Zealand in the third quarter of 2008 (this contract will be closing soon). So, for example, an inflation rate of 5.1% would result in the contract closing at 51 cents. The interpretation of the contract price is the expected value of the variable being predicted e.g. a contract price of $0.51 means we expect inflation will be 5.1%.

These two contract types give us considerable flexibility. An important idea on designing a contract is having the contract's payout struct vary in a way that is compatible with the parameter being measured. One could obtain an expected value for inflation by runing 20 binary contracts asking whether inflation will be between 4.9-5.0%, 5.0-5.1%, etc. But a single indexed contract will do the same job and will almost certainly be more efficient (read: accurate). (running 20 binary contracts is useful to answer a different question: what is the distribution of beliefs about a future event).

# Conditional: these contracts pay out according to the outcome of one variable depending on some other variable being true. For example, you could define a contract that pay out 1 cent for each 1% of inflation reported in Q3 2009 given Labour leads the next government. This contract would payout $0 if National (or anybody else other than Labour) leads the next goverment.

Conditional contracts is the prediction market tool used for investigating policy questions. If we were to run another conditional contract alongside the example above, but instead conditional on National leading the next government, then an examination of the difference between the prices of the two conditional contracts - one conditional on Labour leading, the other conditional on National - can tell us what traders think about the effect of each party's policies on unemployment by this time next year.

The analysis is a bit more complicated than that, actually. The conditional market prices have to be weighted by the likelihoods that Labour or National will lead the next government. But bottom line, even with this mild complexity, we should expect some reasonable estimates to come out of these markets given enough liquidity.

But there's the rub with conditional markets. They are fine in theory, yet nobody has yet found a way to make them sufficiently attractive to traders to make those markets truly liquid. InTrade runs conditional markets, and removed all fees from trades on some of those markets in an effort to stimulate activity. It didn't work.

We at iPredict have some ideas on making conditional markets easy to understand, and we intend launching them in the coming weeks.