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Today's Availability Cascade

All of the experts thought that Barack Obama would win the New Hampshire primary. Perhaps more significantly, the prices at Intrade, the political prediction market, suggested that Obama was overwhelmingly likely to win. Many of us have been quite excited about the potential of prediction markets, in which people "bet" on political (and many other) outcomes. Such markets have a terrific track record in politics and elsewhere. And yet Clinton was a huge underdog in New Hampshire. Should we conclude that the prediction markets are unreliable after all? That nobody knows anything? That polls themselves mean nothing?

The answers are no, no, and no. The problem is that as in so many domains, a single, unlikely event (here, the stunning surprise in New Hampshire) is leading to a false generalization about the world.

More particularly: Intrade had Clinton at about 8 percent likely to win, and 8 percent of the time, 8 percent chances should come through. (As in horse races, so on Intrade.) It would be a great surprise if 8 percent chances come though 0 percent or even 2 percent of the time. But on prediction markets, prices have generally been close to probabilities. Events that are priced to be 90 percent likely to happen occur about 90 percent of the time, events that are priced to be 70 percent likely to happen occur about 70 percent of the time, and so on.

This week's skepticism about prediction markets is being driven by the well-known availability heuristic, in accordance with which people assess probability by asking whether events come easily to mind, or are cognitively "available." The success of the long-shot in New Hampshire is now very available indeed. In fact we are witnessing an availability cascade, in which the single incident spreads rapidly from one person to another, leading to the (false) belief that the prediction markets are quite unreliable. This kind of availability cascade is similar to what is observed in the domains of risk and fear, in which a particular event becomes highly salient and is taken, wrongly, to suggest something general about social hazards.

There is a broader point. Some people are now doubting not only the prediction markets but also the polls, saying that no one knows anything, and that anything is as likely as anything else. Don't believe it. To be sure, we are continuing to obtain information about how prediction markets perform and when they do well and poorly. Perhaps they will turn out to be less reliable than they seem -- and in all likelihood, we will obtain a better understanding of when they work. And of course no one has a crystal ball. But the polls are generally pretty good -- and if you want to have a sense of the probabilities, you'd probably do best to consult Intrade.

Full post as published by The University of Chicago Law School Faculty Blog on January 10, 2008 (boomark / email).