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Prediction market

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Prediction markets (also known as predictive markets, information

markets, decision markets, idea futures, event derivatives, or virtual markets)are speculative markets created for the purpose of making predictions. The

current market prices can then e interpreted as predictions of the proaility ofthe event or the e!pected value of the parameter. For e!ample, a

 prediction market security might reward a dollar if a particular candidate is elected,such that an individual who thinks the candidate had a "#$ chance of eing

elected should e willing to pay up to "# cents for such a security.

%eople who uy low and sell high are rewarded for improving the market prediction, while those who uy high and sell low are punished for degrading the

market prediction. &vidence so far suggests that prediction markets are at least asaccurate as other institutions predicting the same events with a similar pool of

 participants.'

Contents

 'hide

• *istory

• + ccuracy

o +. -ources of inaccuracy

• /ther issues

o . 0egality

o .+ 1ontroversial incentives

• 2 %ulic prediction markets

• 3 4se y corporations

• 5 -ee also

• " 6eferences

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• 7 cademic %apers

• 8 &!ternal 6esources

History[edit]

&conomic theory for the ideas ehind prediction markets can e credited toFriedrich *ayek in his 823 article 9The 4se of nowledge in -ociety9 and

0udvig von ;ises in his 9&conomic 1alculation in the -ocialist 1ommonwealth9.;odern economists agree that ;ises< argument comined with *ayek<s elaoration

of it, is correct (9=iography of 0udwig &dler von ;ises (77>8"),9 The1oncise &ncyclopedia of &conomics). /ne of the oldest and most famous is

the 4niversity of ?owa<s ?owa &lectronic ;arkets, introduced during the 877 4.-. presidential election.'+ The *ollywood -tock &!change, a virtual market game

estalished in 885 and now a division of 1antor Fit@gerald, 0%, in which players uy and sell prediction shares of movies, actors, directors, and filmArelated options,

correctly predicted + of +##5<s 8 igAcategory /scar  nominees and " out of 7 topcategory winners. *edge-treet, designated in 88 as a market and regulated y

the 1ommodity Futures Trading 1ommission, enales ?nternet traders to speculateon economic events.

%rediction markets have a long and colorful lineage. =etting on elections wascommon in the 4.-. until at least the 82#s, with formal markets e!isting on Wall

-treet in the months leading up to the race. Bewspapers reported market conditionsto give a sense of the closeness of the contest in this period prior to widespread

 polling. The markets involved thousands of participants, had millions of dollars involume in current terms, and had remarkale predictive accuracy. '

round 88# at %roCect Danadu, 6oin *anson used the first known corporate prediction market. &mployees used it in order to et on, for e!ample, the cold

fusion controversy.

?n +##, ?ntrade.com launched a prediction market trading platform from ?reland

allowing real money trading etween memers on contracts related to a numer ofdifferent categories including usiness issues, current events, financial topics, and

more. ?ntrade ceased trading in +#.

?n July +##, the 4.-. Eepartment of Eefense pulici@ed a %olicy nalysis

;arket and on their wesite speculated that additional topics for markets mightinclude terrorist attacks. critical acklash uickly denounced the program as a

9terrorism futures market9 and the %entagon hastily canceled the program.

%rediction markets are championed in James -urowiecki<s +##2 ook The Wisdom

of Crowds, 1ass -unstein<s +##5 Infotopia, and How to Measure Anything: Finding the Value of Intangibles in Business y Eouglas *uard.'2

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The research literature is collected together in the peer reviewed The ournal of !redi"tion Mar#ets, edited y 0eighton Gaughan Williams and pulished y

the 4niversity of =uckingham %ress. The Cournal was first pulished in +##", andis availale online and in print.'3

?n John =runner <s 8"3 science fiction story The $ho"#wa%e &ider  there is adescription of a prediction market that he called the Eelphi %ool.

?n /ctoer +##" companies from the 4nited -tates, ?reland, ustria, Hermany, andEenmark formed the %rediction ;arket ?ndustry ssociation, '5 tasked with

 promoting awareness, education, and validation for prediction markets.

Accuracy[edit]

-ome academic research has focused on potential flaws with the prediction marketconcept. ?n particular, Er. 1harles F. ;anski of Borthwestern 4niversity pulished9?nterpreting the %redictions of %rediction ;arkets9, '" which attempts to show

mathematically that under a wide range of assumptions the 9predictions9 of suchmarkets do not closely correspond to the actual proaility eliefs of the market

 participants unless the market proaility is near either # or . ;anski suggeststhat directly asking a group of participants to estimate proailities may lead to

 etter results.

*owever, -teven HCerstad (%urdue) in his paper 96isk version, =eliefs, and

%rediction ;arket &uilirium,9'7 has shown that prediction market prices are veryclose to the mean elief of market participants if the agents are risk averse and the

distriution of eliefs is spread out (as with a normal distriution, fore!ample). Justin Wolfers (Wharton) and &ric Iit@ewit@ (Eartmouth) have otained

similar results, and also include some analysis of prediction market data, in their paper 9?nterpreting %rediction ;arket %rices as %roailities.9'8 ?n practice, the

 prices of inary prediction markets have proven to e closely related to actualfreuencies of events in the real world. '#'

Eouglas *uard has also conducted a sample of over 2## retired claims whichshowed that the proaility of an event is close to its market price ut, more

importantly, significantly closer than the average single suCective estimate.'2*owever, he also shows that this enefit is partly offset if individuals first

undergo calirated proaility assessment training so that they are good atassessing odds suCectively. The key enefit of the market, *uard claims, is that

it mostly adCusts for uncalirated estimates and, at the same time, incentivi@esmarket participants to seek further information.

series of laoratory e!periments to compare the accuracy of prediction markets,

traditional meetings, the Eelphi method, and the nominal group techniue on auantitative Cudgment task, found only small differences etween these four

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methods. Eelphi was most accurate, followed y BHT and prediction markets.;eetings performed worst. The study also looked at participants< perceptions of the

methods. %rediction markets were rated least favourale: prediction market participants were least satisfied with the group process and perceived their method

as the most difficult.'

common elief among economists and the financial community in general is that

 prediction markets ased on play money cannot possily generate credile predictions. *owever, the data collected so far disagrees.'# naly@ed data from the

*ollywood -tock &!change and the Foresight &!change concluded that market prices predicted actual outcomes andor outcome freuencies in the real world.

1omparing an entire season<s worth of BF0 predictions from BewsFutures< playAmoney e!change to those of Tradesports, an euivalent realAmoney e!change ased

in ?reland, oth e!changes performed eually well. ?n this case, using real money

did not lead to etter predictions.'

*ollywood -tock &!change creator ;a! eiser  suggests that not only are thesemarkets no more predictive than their estalished counterparts such as the Bew

Kork -tock &!change and the 0ondon -tock &!change, ut that reducing theunpredictaility of markets would mean reducing risk and, therefore, reducing the

amount of speculative capital needed to keep markets open and liuid.