Prediction markets are speculative markets created for the purpose of making predictions. Assets are created whose final cash value is tied to a particular event (e.g., will the next US president be a Republican) or parameter (e.g., total sales next quarter). The current market prices can then be interpreted as predictions of the probability of the event or the expected value of the parameter. Prediction markets are thus structured as betting exchanges, without any risk for the bookmaker. Image File history File links This is a lossless scalable vector image. ... Speculation involves the buying, holding, and selling of stocks, bonds, commodities, currencies, collectibles, real estate, derivatives or any valuable financial instrument to profit from fluctuations in its price as opposed to buying it for use or for income via methods such as dividends or interest. ... A bet exchange or p2p gambling web site is a fairly recent Internet phenomenon, and is used to describe a web site acting as a broker between parties for the placement of bets (gambling, in other words). ...

Other names for prediction markets include information markets, decision markets, idea futures, event derivatives, and virtual markets.

People who buy low and sell high are rewarded for improving the market prediction, while those who buy high and sell low are punished for degrading the market prediction. Evidence so far suggests that prediction markets are at least as accurate as other institutions predicting the same events with a similar pool of participants.

Examples of prediction markets open to the public include: Intrade, Betfair, TradeSports, the Iowa Electronic Markets,NewsFutures, Bet2Give, Hollywood Stock Exchange, The simExchange, and the Popular Science Predictions Exchange. Tradesports is an online trading exchange whose members speculate on the outcomes of future events in sports, politics, financial markets, pop culture, the weather, and other areas, with a niche in U.S. politics, geopolitics, and current events. ... Betfair Logo Betfair is the worlds largest Internet betting exchange. ... Tradesports, similar to Betfair, is an on-line sports betting exchange. ... The Iowa Electronic Markets, or IEM, are a group of real-money futures markets that allow traders to buy and sell contracts based on, among other things, political election results. ... NewsFutures is a prediction game in the form of a stock market, otherwise known as a prediction market. ... Hollywood Stock Exchange, December 2005 The Hollywood Stock Exchange, or HSX, is a web-based, multiplayer game in which players use simulated money to buy and sell shares of actors, directors, upcoming films, and film-related options. ... The simExchange is a web-based prediction market in which players use virtual money to buy and sell stocks and futures contracts in upcoming video game properties. ... Popular Science Predictions Exchange (PPX) is an online Prediction market run as part of the Popular Science Magazine website. ...

History

One of the oldest and most famous is the University of Iowa's Iowa Electronic Market. The Hollywood Stock Exchange, a virtual market game established in 1996 and now a division of Cantor Fitzgerald, LP, in which players buy and sell prediction shares of movies, actors, directors, and film-related options, correctly predicted 32 of 2006's 39 big-category Oscar nominees and 7 out of 8 top category winners. HedgeStreet, designated in 2004 as a market and regulated by the Commodity Futures Trading Commission, enables internet traders to speculate on economic events. The University of Iowa, also commonly called Iowa or locally UI, is a major coeducational research university located on a 1,900-acre (8 km²) campus in Iowa City, Iowa, US, on the banks of the Iowa River in East Central Iowa. ... Hollywood Stock Exchange, December 2005 The Hollywood Stock Exchange, or HSX, is a web-based, multiplayer game in which players use simulated money to buy and sell shares of actors, directors, upcoming films, and film-related options. ... Cantor Fitzgerald Securities is an investment bank specializing in bond trading. ... Year 2006 (MMVI) was a common year starting on Sunday of the Gregorian calendar. ... Academy Award The Academy Awards, popularly known as the Oscars, are the most prominent and most watched film awards ceremony in the world. ... The Commodity Futures Trading Commission (CFTC) is an independent agency of the United States Government, created by Congress in 1974. ...

Prediction markets actually have a long and colorful lineage. Betting on elections was common in the U.S. until at least the 1940s, with formal markets existing on Wall Street in the months leading up to the race. Newspapers reported market conditions to 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 in volume in current terms, and had remarkable predictive accuracy.^[1]

Around 1990 at Project Xanadu, Robin Hanson used the first known corporate prediction market. Employees used it in order to bet on for example the cold fusion controversy. Project Xanadu was founded by Ted Nelson in 1960 as the original hypertext project. ... Robin Hanson is an associate professor of economics at George Mason University. ... This article is about the nuclear reaction. ...

In July 2003, the U.S. Department of Defense publicized a Policy Analysis Market and on their website speculated that additional topics for markets might include terrorist attacks. A critical backlash quickly denounced the program as a "terrorism futures market" and the Pentagon hastily cancelled the program. 2003 : January - February - March - April - May - June - July - August - September - October - November - December A timeline of events in the news for July, 2003. ... The United States Department of Defense, abbreviated DoD or DOD and sometimes called the Defense Department, is a civilian Cabinet organization of the United States government. ... The Policy Analysis Market (PAM) was a proposed futures exchange developed by the United States Defense Advanced Research Projects Agency and based on an idea first proposed by Net Exchange[1], a San Diego research firm specializing in the development of online markets. ... Terrorist redirects here. ... This article is about the United States military building. ...

Prediction markets are championed in James Surowiecki's 2004 book The Wisdom of Crowds, Cass Sunstein's 2006 Infotopia, and How to Measure Anything: Finding the Value of Intangibles in Business by Douglas Hubbard^[2]. James Surowiecki James Michael Surowiecki (b. ... The Wisdom of Crowds: Why the Many Are Smarter Than the Few and How Collective Wisdom Shapes Business, Economies, Societies and Nations, first published in 2004, is a book written by James Surowiecki about the aggregation of information in groups, resulting in decisions that, he argues, are often better than... Cass R. Sunstein (b. ...

The research literature is collected together in the peer reviewed The Journal of Prediction Markets, edited by Leighton Vaughan Williams and published by the University of Buckingham Press. The journal was first published in 2007, and is available online and in print.^[3]

Accuracy

Some academic research has focused on potential flaws with the prediction market concept. In particular, Dr. Charles F. Manski of Northwestern University published “Interpreting the Predictions of Prediction Markets”^[4]., which attempts to show mathematically that under a wide range of assumptions the "predictions" of such markets do not closely correspond to the actual probability beliefs of the market participants unless the market probability is near either 0 or 1. Manski suggests that directly asking a group of participants to estimate probabilities may lead to better results. However, Steven Gjerstad (Purdue) in his paper "Risk Aversion, Beliefs, and Prediction Market Equilibrium" ^[5]. has shown that prediction market prices are typically very close to the mean belief of market participants if the distribution of beliefs is smooth (as with a normal distribution, for example). Justin Wolfers (Wharton) and Eric Zitzewitz (Dartmouth) have obtained similar results, and also include some analysis of prediction market data, in their paper "Interpreting Prediction Market Prices as Probabilities" ^[6]. In practice, the prices of binary prediction markets have proven to be closely related to actual frequencies of event in the real world.^[7][8] Northwestern University (NU) is a private, nonsectarian, coeducational research university with campuses located in Evanston, Illinois and downtown Chicago. ...

Douglas Hubbard has also conducted a sample of over 400 retired claims which showed that the probability of an event is close to its market price but, more importantly, significantly closer than the average single subjective estimate^[9]. However, he also shows that this benefit is partly offset if individuals first undergo calibrated probability assessment training so that they are good at assessing odds subjectively. The key benefit of the market, Hubbard claims, is that it mostly adjusts for uncalibrated estimates and, at the same time, incentivizes market participants to seek further information. Calibrated Probability Assessments are subjective probabilities assigned by individuals who have been trained to assess probabilities in a way that historically represents their uncertainty[1][2]. In other words, when a calibrated person says they are 80% confident in each of 100 predictions they made, they will get about 80...

A common belief among economists and the financial community in general is that prediction markets based on play money cannot possibly generate credible predictions. However, the data collected so far disagrees^[7]. Analyzed data from the Hollywood Stock Exchange and the Foresight Exchange concluded that market prices predicted actual outcomes and/or outcome frequencies in the real world. Comparing an entire season's worth of NFL predictions from NewsFutures' play-money exchange to those of Tradesports, an equivalent real-money exchange based in Ireland, both exchanges performed equally well. In this case, using real money did not lead to better predictions^[8].

Hollywood Stock Exchange creator Max Keiser suggests that not only are these markets no more predictive than their established counterparts such as the New York Stock Exchange and the London Stock Exchange, but that reducing the unpredictability of markets would mean reducing risk and, therefore, reducing the amount of speculative capital needed to keep markets open and liquid. Hollywood Stock Exchange, December 2005 The Hollywood Stock Exchange, or HSX, is a web-based, multiplayer game in which players use simulated money to buy and sell shares of actors, directors, upcoming films, and film-related options. ... The New York Stock Exchange (NYSE), nicknamed the Big Board, is a New York City-based stock exchange. ... The Source by Greyworld, in the new LSE building Paternoster Square. ...

Sources of inaccuracy

Prediction markets suffer from the same types of inaccuracy as other kinds of market, i.e. liquidity or other factors not intended to be measured are taken into account as risk factors by the market participants, distorting the market probabilities. Prediction markets may also be subject to speculative bubbles. For example, in the year 2000 IEM presidential futures markets, a flood of new traders in the final week of the election caused the market to gyrate wildly, making its "predictions" useless.

There can also be direct attempts to manipulate such markets. In the Tradesports 2004 presidential markets there was an apparent manipulation effort. An anonymous trader sold short so many Bush 2004 presidential futures contracts that the price was driven to zero, implying a zero percent chance that Bush would win. The only rational purpose of such a trade would be an attempt to manipulate the market in a strategy called a "bear raid". If this was a deliberate manipulation effort it failed, however, as the price of the contract rebounded rapidly to its previous level. As more press attention is paid to prediction markets, it is likely that more groups will be motivated to manipulate them. However, in practice, such attempts at manipulation have always proven to be very short lived. In their paper entitled "Information Aggregation and Manipulation in an Experimental Market" (2005),^[10] Hanson, Oprea and Porter (George Mason U), show how attempts at market manipulation in fact end up increasing the accuracy of the market because they provide that much more profit incentive to bet against the manipulator. Tradesports, similar to Betfair, is an on-line sports betting exchange. ... Market manipulation describes a deliberate attempt to interfere with the free and fair operation of the market and create artificial, false or misleading appearances with respect to the price of, or market for, a stock. ...

Related prediction methods

Some experimental systems are underway to provide data on alternatives to prediction markets that seek to avoid some of the theoretical pitfalls mentioned above. For example, polling firm TIPP Online has experimented with "national zeitgeist" questions which ask participants who they think will win rather than who they will vote for personally. This proved to be a more stable and accurate predictor in the 2004 US presidential race than traditional polls. Another experimental system is Owise which directly asks participants to estimate probabilities on a wide range of future events, and rewards accurate performance with status, titles, and small cash prizes. Owise functions as a hive mind or a kind of neural network in which each "neuron" is a human being whose predictions are assigned a weight based on past performance. In fact, this is not so different from what naturally happens in a prediction market where those who make good predictions do profit at the expense of those who make bad predictions, thus progressively increasing their relative influence on the market through how much money they can bring to bear to back up their predictions. There is currently not enough data and history to check how these alternatives will compare to prediction markets in terms of forecasting ability. A hive mind (sometimes spelled hivemind) is a form of collective consciousness strongly exhibiting traits of conformity and groupthink. ... // Traditionally, the term neural network had been used to refer to a network or circuitry of biological neurons. ...

Other issues

Legality

Because online gambling is outlawed in the United States through federal laws and many state laws as well, most prediction markets that target U.S. users operate with "play money" rather than "real money": they are free to play (no purchase necessary) and usually offer prizes to the best traders as incentives to participate. Notable exceptions are Intrade/TradeSports, which escapes U.S. legal restrictions by operating from Dublin, Ireland, where gambling is legal and regulated, the Iowa Electronic Markets, which operates from the University of Iowa under the cover of a no-action letter from the Commodity Futures Trading Commission and allows bets up to $500, and finally US-based Bet2Give, a real-money market which doesn't qualify as "gambling" because it requires that trading profits be given to winner-chosen non-profit organizations. Tradesports is an online trading exchange whose members speculate on the outcomes of future events in sports, politics, financial markets, pop culture, the weather, and other areas, with a niche in U.S. politics, geopolitics, and current events. ... Tradesports, similar to Betfair, is an on-line sports betting exchange. ... The Iowa Electronic Markets, or IEM, are a group of real-money futures markets that allow traders to buy and sell contracts based on, among other things, political election results. ... The Commodity Futures Trading Commission (CFTC) is an independent agency of the United States Government, created by Congress in 1974. ...

Controversial incentives

Some kinds of prediction markets may create controversial incentives. For example, a market predicting the death of a world leader might be quite useful for those whose activities are strongly related to this leader's policies, but it also might turn into an assassination market. An assassination market is a theoretical market wherein any party can place a bet (using anonymous electronic money, and pseudonymous remailers) on the date of death of a given individual, and collect a payoff if they guess the date accurately. ...

Use by corporations

• The simExchange introduced a perpetual contract that it calls "stocks" to predict the global, lifetime sales of video game consoles and software titles. These stocks do not expire like most contracts on prediction markets because the founder, Brian Shiau, argued that video game sales can continue for years.^[11] The premise for these stocks is that Shiau believes the video game industry suffers from a "lack of comprehensive sales data" and he compares the information problem of a game's sales to the information problem of evaluating a company's market value. Hanson warns that such a system may not work if a connection is not enforced.^[12] Keith Gamble has described the simExchange as a Keynesian beauty contest^[13] and that financial markets have certain remedies such as company buy-outs that cannot happen on the simExchange. Gamble concludes that such a prediction market can work but will be confined to play money.^[14]

• Hewlett-Packard pioneered applications in sales forecasting and now uses prediction markets in several business units. Mentioned in academic publications from HP Labs. Also mentioned in Newsweek.^[15] It is working towards a commercial launch of the implementation as a product, BRAIN (Behaviorally Robust Aggregation of Information Networks).^[16]

• Corning, Renault, Eli Lilly, Pfizer, Siemens, Masterfoods, Arcelor Mittal and other global companies are listed as NewsFutures customers.

• Intel mentioned in Harvard Business Review (April 2003) in relation to managing manufacturing capacity.

• Microsoft is piloting prediction markets internally.

• France Telecom's Project Destiny has been in use since mid-2004, with very successful predictive behaviour.

• Google has confirmed that it uses a predictive market internally in its official blog.^[17][18]

• The Wall Street Journal reported that General Electric uses prediction market software from Consensus Point to generate new business ideas.^[19]

• BusinessWeek lists MGM and Lionsgate Studios as two of HSX's clients.^[20]

• Abbott Labs, O'Reilly Media, and the Institute for the Future are listed as Inkling Customers.^[21]

• HSX built and operated a televised virtual stock market, the Interactive Music Exchange for Fuse Networks Fuse TV to be used as the basis of their daily live television broadcast, IMX, which ran from January, 2003 through July, 2004. The television audience traded virtual stocks of artists/videos/songs, and predicted which would make it to the top of the Billboard music charts. The first of its kind, Fuse Network and HSX won an AFI Enhanced TV (American Film Institute) Award for innoviation in television interactivity.^[22]

• Starwoods embraced the use of prediction markets for developing and selecting marketing campaigns. Marketing department started out with some initial ideas and allowed employees to add new ideas or make changes to existing ones. Then subsequently incentives based prediction markets were leveraged to select the best of the lot.

Image File history File links No higher resolution available. ... A Keynesian beauty contest is a concept developed by John Maynard Keynes and introduced in his masterwork, General Theory of Employment Interest and Money (1936), to explain price fluctuations in equity markets. ... The Hewlett-Packard Company (NYSE: HPQ), commonly known as HP, is a very large, global company headquartered in Palo Alto, California, United States. ... NewsFutures is a prediction game in the form of a stock market, otherwise known as a prediction market. ... This article is about the corporation. ... The Wall Street Journal is an influential international daily newspaper published in New York City, New York with an average daily circulation of 1,800,607 (2002). ... GE redirects here. ... The Hollywood Stock Exchange is a web-based, multiplayer game in which players virtually buy and sell shares of actors, directors, upcoming films, and film-related options. ... The Institute for the Future (IFTF) is an independent nonprofit research group. ... The Hollywood Stock Exchange is a web-based, multiplayer game in which players virtually buy and sell shares of actors, directors, upcoming films, and film-related options. ... Fuse is a music video-oriented television channel. ... Starwood headquarters in White Plains “Starwood” redirects here. ...

See also

• Election Stock Market
• Policy Analysis Market
• Foresight Exchange
• Prediction games
• Futarchy - a form of government which would use prediction markets to evaluate public policy
• Futures market

Election Stock Markets are financial markets in which the ultimate values of the contracts being traded are based on the outcome of elections. ... The Policy Analysis Market (PAM) was a proposed futures exchange developed by the United States Defense Advanced Research Projects Agency and based on an idea first proposed by Net Exchange[1], a San Diego research firm specializing in the development of online markets. ... The Foresight Exchange is an online futures market game in which players attempt to gain a high score by accurately predicting the future. ... Prediction Games are games which allow users to guess at the outcome of future events. ... Futarchy is a form of government proposed by economist Robin Hanson, in which elected officials define measures of national welfare and prediction markets are used to determine which policies will have the most positive effect. ... A futures contract is a form of forward contract, a contract to buy or sell an asset of any kind at a pre-agreed future point in time, that has been standardised for a wide range of uses. ...

References

Dr. Steve Lawrence was among the group at NEC Research which was responsible for the creation of the Search Engine/Digital Library CiteSeer. ... Science is the academic journal of the American Association for the Advancement of Science and is considered one of the worlds most prestigious scientific journals. ...

External links

• Prediction Markets For Promoting the Progress of Science and the Useful Arts - by Tom W. Bell - PDF file - George Mason Law Review (14 Geo. Mason L. Rev 37) (2006)
• The Informed Press Favored the Policy Analysis Market - by Robin Hanson - PDF file - 2005-05-05
• The Iowa Electronic Market: Lessons Learned and Answers Yearned - by Joyce E. Berg and Thomas A. Rietz - PDF file - 2005-01-00
• Prediction Markets - by Justin Wolfers and Eric Zitzewitz - PDF file - 2004-05-00
• Interpreting Prediction Market Prices as Probabilities - by Justin Wolfers and Eric Zitzewitz - PDF file - Draft version 2007-01-08 - Expands on the work of Manski, providing a more general model wherein it is somewhat rational to interpret market prices as probabilities
• Interpreting the Predictions of Prediction Markets - by Charles F. Manski - PDF file - Revised Aug 2005 -- Manski suggests that there needs to be a better theoretic basis for interpreting market prices as probability, and provides a simple model for this.
• Betfair Prediction Markets Information Portal - including an expert column by one of the world's leading prediction market experts, Professor Leighton Vaughan Williams. Vaughan Williams runs a weekly column that looks into the world of prediction markets in a practical sense as well as the theory behind them.