Prediction markets and betting on real life events

USA is getting closer to the 2012 Presidential elections and many are wondering who will occupy the White House for the next four years (Obama or Romney).  But just maybe you are more interested whether NASA will announce discovery of aliens before a certain day? Or some other real-life event holds your interest. Well there is a good chance that you can find an event you are interested in and vote about its future outcome.

To do that you need to visit one of the many Prediction Markets on the web and bet. But what is exactly Prediction Market? It is a place, where you can make predictions on the outcome of hundreds of real-world events by betting on the outcome you believe is most likely to happen.

Additionally prediction markets incorporate new information continuously. This has been garnering increased interest of researchers in the recent years. Those prediction markets can turn the wisdom of the crowd, as coined by James Surowiecki, into better tool for predictions than polls, media and political experts, academics and others.

What is valuable is that prediction markets can aggregate small knowledge from various entities into a collective intelligence that together pulls the right answer. The good thing is that being right in the prediction market is valued by winning money, while losers receive nothing, or even lose money through their betting, therefore people would want to provide valuable information.

But for that to work, James Surowiecki1 identified 4 factors for determining the wisdom of the crowd:

  • The crowd needs to possess diverse information: ”each person should have some private information, even if it’s just an eccentric interpretation of the known facts”
  • Members should not be influenced by others when making a decision
  • Decisions should be made based on the personally available information, and not based on centralized source
  • There should be an adequate algorithm to aggregate predictions and generate correct results

Of course using market prices to forecast events has its beginnings from 16th century, and was used widely during the 1940s in USA for betting on political outcomes. Their popularity is on the rise again from the 1990s when researchers in University of Iowa established a small-scale political derivatives market now called the Iowa Electronics Market (IEM) to track votes shares and chances of victory for candidates.

According to a paper from Justin Wolfers2, most prediction markets are established like equity markets. He adds that other designs include play-money market, pari-mutuel markets and market scoring rule.

For example the prediction market Intrade is set up as equity market. It allows you to make predictions on various real life events – from elections, foreign affairs, entertainment, economics, scientific and so on and so forth. In the platform, you buy and sells shares on the outcome of real-life events. And the conditions for those events are always binary- YES/NO proposition.

Another platform is iPredict, which runs since 2008  as a market-based political and economic forecasting system with over 5000 traders.

If you are solely interested in SCOTUS decisions, you can participate and bet of FantasySCOTUS prediction market, established by Harlan Institute. It allows you to bet not only on the type of decisions  SCOTUS reaches (affirm/reverse), but also on the individual votes from judges as well as on the ratio which voted to affirm/reverse a case.

For the markets to work, there need to cover three prerequisites, as listed by Justin Wolfers, professor at Wharton School of Business:

  • Work as aggregator of information
  • Better information results in reward, thus there is financial incentive for correct information
  • “The existence of a market provides longer-term incentives for specialization in discovering novel information and trading on it.”

Of course not in every case, the wisdom of the crowd makes better predictions, but it is a field that is generating more and more attention with some interesting results so far. Even Google has been experimenting with prediction markets that ran among the search engine’s employees.

So far prediction markets have been used for many purposes and more research is needed to establish how valuable they are. Currently, Intrade betting shows that Obama has 59% of winning the 2012 election (decreased with 4% over the period 10-13 October).

Additional Resources:

NYtimes Economic blog

Polling Report

Freakonomics site

 

  1. James Surowiecki. The Wisdom of Crowds. Anchor, August 2005
  2. Snowberg, Erik, Wolfers, Justin and Zitzewitz, Eric, Prediction Markets for Economic Forecasting (July 1, 2012). CAMA Working Paper 33/2012. Available at SSRN: http://ssrn.com/abstract=2102420

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