AEI-Brookings Joint Center Prediction Markets Conference
About This Event
Information markets are markets for contracts that yield payments based on the outcome of an uncertain future event. They are used to predict a wide range of events, from presidential elections to printer sales. These markets frequently outperform both experts and opinion polls, and many scholars believe they have the Listen to Audio


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potential to revolutionize policymaking. The AEI-Brookings Joint Center Prediction Markets Conference, co-hosted by the Prediction Markets Industry Consortium, featured a number of the leading scholars and practitioners of information markets, whose diverse backgrounds fostered discussions covering the many applications of information markets.
Agenda
8:45 a.m.
Registration
9:00
Welcome:
Robert Hahn, AEI-Brookings Joint Center
9:15
Presentations:
Robin Hanson, George Mason University
Robert Hahn, Joint Center
Justin Wolfers, Wharton School
Emile Servan-Schreiber, Newsfutures
Peter Leitner, Numeria
John Delaney, Intrade, Tradesports
3:15 p.m.
Panel:
Robert Hahn, Robin Hanson, Emile Servan-Schreiber, Philip Polgreen, Justin Wolfers
4:00
Adjournment
Event Summary

January 2007

AEI-Brookings Joint Center Prediction Markets Conference

Information markets, also known as prediction markets, are markets for contracts that yield payments based on the outcome of an uncertain future event. They are used to predict a wide range of events, from presidential elections to printer sales. These markets frequently outperform both experts and opinion polls, and many scholars believe they have the potential to revolutionize policymaking.

The AEI-Brookings Joint Center Prediction Markets Conference at AEI on January 18, 2007, co-hosted by the Prediction Markets Industry Consortium, featured a number of the leading scholars and practitioners of information markets, whose diverse backgrounds fostered discussions covering the many applications of information markets.

Robin Hanson
George Mason University

The pertinent question for evaluating a prediction market as a forecasting tool is how it compares to alternative forecasting methods. Studies show that prediction markets are often more accurate than other forecasting methods, such as deliberation amongst a committee of experts or polling a large population. Prediction markets are especially accurate when information on a given topic is dispersed over a population, or when it is unclear who the experts are.

Prediction markets may be used in a variety of ways by companies. One kind of prediction market is a “morale market,” which uses light topics to boost employee morale or determine employee attitudes. “Decision markets,” on the other hand, provide information on serious matters on which important business decisions turn, such as expected sales for the coming term. Currently, morale markets are more commonly used by firms, perhaps because managers fear that a decision market may provide unwanted information, suggesting, for example, that sales for a coming term will be low.

Robert W. Hahn
AEI-Brookings Joint Center for Regulatory Studies

A cost-benefit analysis on the regulation of prediction markets suggests that the regulation should be changed. Under current law, it is neither easy nor inexpensive to legally operate a prediction market in the United States. One solution is to change the regulatory paradigm to allow carve-outs for certain types of prediction-market researchers and entrepreneurs.

Prediction markets are worthy of the attention of regulators because they can improve economic decisions in many areas. Prediction markets can be used to make the regulation process more transparent, hold regulators and legislators more accountable, help with the problem of legislative oversight, and improve economic efficiency.


Justin Wolfers
Wharton School, University of Pennsylvania

While prediction markets can be valuable for forecasting, there are constraints on their use. To function well a market must have sufficient liquidity. Topics for which information is not widely dispersed will fail to attract a sufficient number of traders, and the prediction market will not work well. Another potential problem is “outcome contractibility” or the extent to which the outcome of interest can be precisely defined. The final concern is that prediction markets can be manipulated by renegade traders trying to skew results. Studies have shown, however, that manipulative efforts are usually quickly unraveled and that the market will correct itself.

The results of prediction markets must be carefully interpreted. Prediction markets offer probabilities of events occurring, but they do not offer sure results. Also, one must avoid the temptation to confound correlation and causation. Because markets may find that two events are both likely to occur does not imply that there is some causal relationship between the events.

Emile Servan-Schreiber
NewsFutures

Prediction markets can play an important role in corporations, but corporations currently are unprepared to use them to their full potenial. Fearing an unfavorable forecast, many managers are unwilling to use prediction markets. Due to a lack of appreciation for the power of prediction markets, employees of a corporation may be unwilling to put the time or effort into trading in the market.

Another important consideration for prediction markets is whether they are real-money or play-money markets, because evidence suggests that the accuracy of a market is not determined by whether the money is real. Despite this, observers of the market take the results of real-money markets more seriously.

Peter Leitner
Numeria

It will take time for corporations to embrace prediction markets. Prediction markets provide information that is not only more accurate but also more public.  While this increase in accuracy and transparency is good for shareholders, it poses a threat to managers, who are accustomed to making decisions “behind a veil.” Managers may fear that the use of prediction markets will expose their failings. Another reason for hesitation is that many managers do not understand how prediction markets work, and hence are skeptical of their usefulness.

John Delaney
InTrade/TradeSports

Useful measures for tracking the development of prediction markets include the number of active traders, the number of orders placed, and the number of contracts opened and closed. TradeSports, perhaps the preeminent real-money prediction market, has seen explosions in all these numbers. Traders have begun to use more sophisticated trading methods, mimicking those of well developed financial markets.

A key challenge to running a prediction market is to induce people to get involved.  Successful prediction markets are those that are effective at getting traders to buy and sell contracts.

Philip Polgreen
Infectious Disease Society

The Infectious Disease Society (IDS) is applying prediction markets in the public health domain. Influenza, which kills 36,000 people a year, might be better understood with the help of prediction markets.

IDS has faced some opposition. As the abandoned Defense Advanced Research Projects Agency “terrorism futures market” showed, there is a reluctance to apply prediction markets to catastrophic, or otherwise unfortunate, events. Critics are appalled by the prospect of profiting from accurately predicting others’ misfortune.

This discomfort has to do with the fact that critics do not understand the value of markets as predictive tools, and that these markets actually work toward the public good. One method of circumventing this misunderstanding is to highlight the information-aggregation powers of prediction markets. Rather than being advertised as a kind of futures market, prediction markets should be described as a sophisticated survey.

Joint Center research assistant David Burk prepared this summary.

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