Introducing: Pdot Version 2
The first version of Pdot, released in September 2018, was nothing more than a proof of concept. I wanted to show that decentralized prediction markets can be used to track the success of individual people in ways that have never been done before. Indexes were created for three public figures (LeBron James, Ariana Grande, and Donald Trump) as examples for how this could work given the right methodology.
The problem with Pdot’s initial approach was obvious — it was not clear what the indexes were actually tracking. Underlying markets were selected in an extremely arbitrary manner, and there was no way to define the implied volatility for each index. The time until resolution was also event-specific, which created additional challenges associated with Augur’s oracle for longer-term markets.
I spent a lot of time soliciting feedback on ways to rebuild the methodology. The result was a fundamental change in how Pdot indexes are constructed, which is described in detail in the “How It Works” section below. TLDR: Pdot indexes are now using scalar markets on Augur (across well-defined, relevant categories for each index) with quarterly market resolution windows.
Below are the specific details on how it all works. I would greatly appreciate any feedback on this new methodology — it is still very much a work in progress!
Check out it at www.pdotindex.com!
How It Works — Version 2:
A Pdot index is a synthetic index that tracks the success of an individual person. The value of each index is derived from the value of a basket of speculative positions held in decentralized prediction markets on Augur. For each index, the portfolio manager will carefully construct a portfolio that tracks the “success” of the index’s target while optimizing for stated levels of volatility. Each index is designed to track performance across one or more of the following dimensions: Achievements & Accolades, Financial Success, and Popularity.
These indexes use special types of prediction markets called Scalar Markets. In a Scalar Market, the final payout is based on the actual outcome’s value within a numerical range — which means that the current share price should represent the “most likely” outcome at a given point in time, as determined by the wisdom of the crowd. As time progresses towards the market’s expiration, the “most likely” outcome may change, and as it does the share price (and thus the index’s value) should adjust accordingly.
To construct an index, the portfolio manager will first select the categories (along with their relative weightings) that will make up the portfolio. The index will then allocate into scalar markets on Augur, based on these weightings, at each market’s current share price. The portfolios are designed to be rebalanced once every 3 months, which means that the underlying markets will typically have an expiration date equal to quarter-end.
Each scalar market will have a minimum and maximum value. This range determines the volatility profile of the market (tighter bands offer more leverage). If the actual outcome ends up at or below the market’s minimum value, the shares will be worth zero. If the actual outcome ends up at or above the market’s maximum value, the shares will be worth two times their value at the midpoint of the range. To ensure an appropriate level of volatility, Pdot will select markets with minimum and maximum values defined by the 5th and 95th percentile outcomes, based on a proprietary analysis performed at the time of market creation. This means that we can expect a 5% chance that the shares will be worth zero at expiration date. Likewise, we can expect a 5% chance that the shares will increase 2x from the midpoint price (which is typically the index’s entry point) at expiration date.
The current value of each index is simply a weighted sum of the adjusted share prices (normalized between 0 and 1) for each market in the index’s portfolio. To control volatility and to ensure that the index’s value will never fall to zero, the index will always keep 10% of the portfolio allocated to “Stable Value”. This means that the index’s value will never fall by more than 90% in a given 3-month period.
A portfolio manager may change the composition of an index at any time (although most changes are expected to occur during the quarterly rollover period). To do this, the total value of the portfolio is reallocated to the new set of markets based on current share prices. Note that a portfolio rebalance will have no immediate impact on the value of the index. The most up-to-date list of each index’s underlying positions (and their relative weightings) will always be visible on Pdot Index.