Prediction Markets

Definition

From Melanie Swan at http://www.melanieswan.com/social_finance.html

Prediction Markets allow "individuals to log their predictions of the outcomes of a variety of events ... Either fictitious or real money or points are used to keep score."

"Economists like Wharton Professor Justin Wolfers have shown that the Wisdom of Crowds of Prediction Markets often beats traditional forecasting methods. Prediction Markets are becoming an increasingly important venue for price, opinion and information discovery. There are several existing prediction markets and free platform software like Zocalo for users to develop their own." (http://www.melanieswan.com/social_finance.html)

Examples

From an article by Melanie Swan at http://www.melanieswan.com/social_finance.html

A few Prediction Markets examples:

Iowa Electronic Markets, at http://www.biz.uiowa.edu/iem/

Hedge Street (A real financial exchange using real money), at http://hedgestreet.com/

Long Bets (affiliated with the Long Now Foundation), at http://www.longbets.org/

The Foresight Exchange Prediction Market, at http://www.ideosphere.com/

Internal Company Prediction Markets

From http://news.com.com/Tech+lessons+learned+from+the+wisdom+of+crowds/2100-1014_3-6143896.html

"Google: It's no secret that Google is using prediction markets internally: Bo Cowgill, a Google project manager, described it in a blog post last year.

Cowgill suggested that companies use reputation systems that encourage employee participation by showing whether someone is scoring better or worse in the prediction realm than his colleagues. "You can have winners in each department," Cowgill said, adding that he'd like Google's employee directory to reveal each person's accuracy.

Google offers cash prizes and T-shirts to employees who score well, and the winners are calculated quarterly, Cowgill said. But he still stressed reputation systems as a better method: "In order to make it attractive in a forward sense you have to spend more and more money or the laws are going to have to change. I don't think either is likely to happen anytime soon."

HP: HP Labs has created betting software called BRAIN that's designed for employees and managers; pharmaceutical giant Pfizer will use it starting next year. The unique feature is that BRAIN assigns people a profile based on how risk-averse they are.

To test BRAIN, HP compared it to existing ways of forecasting memory prices--a key figure since memory represents up to 10 percent of the cost of a computer and HP spends billions of dollars on it a year. Instead of a 4 percent error rate for the existing method of forecasting DDR and DDR2 512MB memory prices, the prediction market had a 2.5 percent error rate, or a 37 percent improvement. A second trial to forecast HP Services operating profits yielded similar results.

"We are able to pay real cash money to people without running afoul" of the Commodity Futures Trading Commission said HP's Leslie Fine, because the betting market gives participants only rewards and does not let them lose money.

Yahoo: David Pennock, a principal research scientist at Yahoo Research, said the company has created a currency called a Yootle. It's described as a "scorekeeping system for favors owed."

See Yahoo! Research and O’Reilly Tech Buzz Game, at http://buzz.research.yahoo.com/

"Pennock offered as an example a programmer offering to write a piece of code for a few Yootles. Or, when organizing a dinner outing, one employee could use an internal SMS tool to bid 2 Yootles for Italian and 4 Yootles for Mexican. "If you don't get to go to the restaurant you want to, you get compensation" in Yootles, he said.

Related to Yootles is Yahoo Research's experiment with a fantasy prediction market for technology called the Tech Buzz Game. It's a modified version of software licensed from NewsFutures in conjunction with O'Reilly Media and features topics like Atlantic hurricanes and portable media devices. Winners are those who predict how popular a topic will be on Yahoo Search." (http://news.com.com/Tech+lessons+learned+from+the+wisdom+of+crowds/2100-1014_3-6143896.html)

More Information

James Surowiecki's landmark book on the Wisdom of Crowds is a good introduction to the underlying logic of why prediction markets work.

This NBER research reportis cited as proof that it works.

Zocalo is an open source software project to create prediction markets, at http://sourceforge.net/projects/zocalo/

Podcasts and webcasts

Bernardo Huberman on Prediction Markets, webcast

Guide to Prediction Markets, audio podcast by Business Week