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JuliaS-FirstPaper 13 - 12 Feb 2008 - Main.JustinColannino
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| | | What are prediction markets?
Prediction markets are essentially an aggregation of betting exchanges for contingent future events. On sites like InTrade and NewsFutures speculators are invited to trade contracts in the markets for scores of different socio-political events; from when China will attack Taiwan, to which Supreme Court Justice will be the next to retire, to whether NASA's next shuttle will rove father than its last. Speculators may buy and sell their contracts at any time, and the market prices - which represent the expected probability of the event - will rise and fall until the contingency occurs, at which point the price will either drop to zero or rise to one hundred and the market will expire. They work like conventional stock markets, except they trade in predictions instead of assets. | |
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> | * Picky point: the market prices reflect the public's expectation that the event will occur NOT the true expected probability of the event. -- JustinColannino - 12 Feb 2008 | | | What are they used for?
Though the idea of such markets is relatively simple, in reality they have staggering implications. As we will explore below, the markets incentivize people to invest based on their very best understanding of the future. By aggregating all this information, the market reflects the wisdom of the masses - wisdom which is proving to be remarkably reliable. Markets for the prediction of controllable social events encourage insiders to trade their information, enabling market analysts to foresee threats and risks. Prediction markets for the behaviors of financial markets offer speculators a potential means of hedging their losses when primary markets fail. Prediction markets for events that are communally controlled - like elections and economic activity - actually have the potential to make themselves come true. Some theorists even believe that prediction markets might be used for decision-making, by creating conditional markets which relate events with other variables. | | | Time Magazine reports: On Dec. 11, 2003, InTrade? 's contract on Saddam Hussein's capture suddenly began to move. "We noticed that that contract started trading from 9 to 30 for no reason," says Mike Knesevitch, communications director. "Something was happening." In fact, someone may well have been trading on inside information. Two days later, Saddam was in custody.
Information as a Commodity | |
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< | Prediction markets may have the potential to generate enormous wealth - it's a whole new economic frontier. But there is something conceptually curious about trading in predictions. Unlike traditional economic markets, the shares you are buying when you invest in a prediction do not represent any tangible, real world thing. When I buy stock in Pepsi Co., technically speaking, I own a percentage of the Pepsi Company and my stock entitles me to a share of its profits. But when I buy stock in the prediction that Antonin Scalia will be the next Supreme Court Justice to leave the bench, what have I bought? What creates the value in this market? It's similar, of course, to standard forms of betting, in that the value is the probability that an event will occur. But standard betting games are not conducted in market-form. The closest analogy I can come up with is the bond market - which trades in debt securities whose values are determined by their future performance. However, those securities are representative of real financial value-assets in a way that event predictions are not. Frankly, I think I lack the economic proficiency to really understand this issue. If anyone would like to jump in here, I'm really interested in trying to figure it out. The question of how such a market should be regulated is also fascinating. If you look at their FAQ, InTrade? admits that they don't know the legal status of their market, and allocates the risk of using it to the speculators. I'm guessing this is a reflection of the fact that we do not yet sufficiently understand these young markets enough to create regulatory guidelines. | >
> | Prediction markets may have the potential to generate enormous wealth - it's a whole new economic frontier. But there is something conceptually curious about trading in predictions. Unlike traditional economic markets, the shares you are buying when you invest in a prediction do not represent any tangible, real world thing. When I buy stock in Pepsi Co., technically speaking, I own a percentage of the Pepsi Company and my stock entitles me to a share of its profits. But when I buy stock in the prediction that Antonin Scalia will be the next Supreme Court Justice to leave the bench, what have I bought? What creates the value in this market? It's similar, of course, to standard forms of betting, in that the value is the probability that an event will occur. But standard betting games are not conducted in market-form.
- The bond market is a great analogy. In fact, this is a simpler form of the bond market. It is a bond market where all bonds pay %0 interest and the only type event you can 'bet on' is whether the company who issued the bond will go bankrupt before the bond is due. -- JustinColannino - 12 Feb 2008
The closest analogy I can come up with is the bond market - which trades in debt securities whose values are determined by their future performance. However, those securities are representative of real financial value-assets in a way that event predictions are not. Frankly, I think I lack the economic proficiency to really understand this issue. If anyone would like to jump in here, I'm really interested in trying to figure it out. The question of how such a market should be regulated is also fascinating. If you look at their FAQ, InTrade? admits that they don't know the legal status of their market, and allocates the risk of using it to the speculators. I'm guessing this is a reflection of the fact that we do not yet sufficiently understand these young markets enough to create regulatory guidelines. | | | Hedging Uncertainty |
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