A prediction market is a market where bets are performed on predictions of events such as elections, changes in stock prices or business of sales. There is no need for representative samples instead of a poll. All bets form a collective decision sometimes recognized as more effective than a survey. Prediction markets make it possible to aggregate opinions and extract unbiased consensus in real time. They are one of the most effective solutions to provide a dynamic view of collective intelligence. Instead prediction market, also referred to as predictive markets, information markets, decision markets, idea futures, event derivatives, or virtual markets.
One of this type of market applications is the market of political analysis that the Pentagon has tried to set up in 2003 to gather intelligence on the likelihood of destabilizing events in eight countries in the Middle East. The objections and criticisms were so numerous that the project was disowned the day after it was unveiled.
In 1988 was created the first prediction market: IEM – the electronic market of Iowa. This electronic system was designed to predict the outcome of the next elections. People can buy and sell “contracts” based on their views regarding the outcome of the candidates. For example if the Bush price is 48 cents, this means that the market thinks that Bush will gather 48% of the votes in the election. Between 1988 and 2000, 596 ballots were compared to the price of the forecast IEM on election day.
It turns out that the I.E.M. was more accurate than polls three times out of four.
There are three reasons why prediction markets rival polls:
First, transparency: the question for bettors is directly related to what we want to predict.
Second, greed: bettors invest and take risks with their money or reputation if the bet is non-monetary. This has the consequence of having motivated stakeholders and looking for the right information.
Third, the “invisible hand“: all bettors try to maximize their profits and are changing their positions to buy or sell whenever they find an interest, which tends to make them balanced prognosis.
The most remarkable prediction markets
In 2007, among the most remarkable prediction markets include Iowa Electronic Markets (The first market predictions set up by researchers), NewsFutures (the first market in French on all news), Tradesports (on sports scores) and Hollywood Stock Exchange (the US box office). The most commonly traded product on the market is the binary option.
In recent years, some companies use predictive markets as internal tools to support the decision. Their fields of application are varied, ranging from forecast (probability of future events, quantitative estimates of key indicators …) to the project management.
It quickly became clear experimentally that prediction markets providing more accurate forecasts than traditional internal projections.
In the United States, Hewlett-Packard, Dentsu, Google, Yahoo! and Lilly are among the precursors that have adopted these prediction markets.