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Prediction Markets – Buying and Sellling the Future
By Neil Peterson | August 26, 2009
It’s not wholly gambling – not in the Vegas sense. But it’s not purely an academic pursuit either – despite it’s uses as a real-world teaching tool. The science of prediction markets is a curious phenomenon – controversial, moderately confusing, and at times, uncommonly accurate. Speculative in nature, prediction markets use the wisdom of the crowd to foretell the outcomes of certain events – whether the election of a political party or the weekend box office results for the latest Bruce Willis action flick. A little bit economics, tea-leaf readings, and data collection. Think of it as gambling for the academically minded.
What is a Prediction Market?
Although public interest has grown considerably in the past two decades, in lockstep with the worldwide adoption of the internet, prediction markets are not a new concept. Prior to the 1940′s, betting money on the outcomes of Presidential elections was common, with Wall Street representation and fluctuations reported in daily newspapers. But what makes this different than say, laying down $1000 on a New England Patriots 2010 Superbowl win is not just the money. Prediction markets are used mainly to gauge public opinion – and to use the data collected to develop stronger theories about our cultural and political leanings. In fact, the amounts of money involved are too small to even merit consideration from the Commodity Futures Trading Commission (CFTC), the industry’s governmental watchdog.
The power of prediction markets is in the ‘pure’ intent of the speculator. Preceding an election, political pollsters collect data on the hoped-for outcome from tens of thousands of citizens. The data represents not what the public believes will happen, but what they want to happen. In using the predictive market model, speculators – by necessity of participation – take into account cold, hard facts, not feelings. (The genius of this model lies here, as to be a ‘winner’ in this arena takes at least a modicum of research, and to step away from one’s own bias.) Or, to put it another way, it’s not about whether the speculator believes in the artistic merit of Bruce Willis’ oeuvre, but whether or not they believe millions of other fans do.
Developed by the University of Iowa Tippie College of Business, the Iowa Electronics Market (IEM) is a not-for-profit organization, and the most often cited prediction market. Run solely for educational/research purposes, investor account holdings cap out at $500. The University uses the IEM to ‘prepare students to be intelligent market participants’, in addition to gaining data on market trends and behavior. Covering political, cultural, and business futures (some of which are only open to students), IEM has a proven track record for accuracy in forecasting election results.
The Hollywood Stock ExchangeS (HSX) uses a slightly different business model, allowing traders (using simulated funds) to buy shares in the Hollywood elite – including actors, directors, and the potential box office returns for upcoming films. Industry insiders have used the HSX as a highly accurate indicator for opening weekend numbers, and to determine which stars are on the ascendancy (and vice versa) in regards to casting future projects. HSX has also shown a remarkable ability to foretell major-category Oscar winners, with 32 of the 39 awards being correctly predicted in 2007.
No one can say for sure what the future will bring. But that hasn’t stopped multinational corporations – including Google, Best Buy, Motorola, and Hewlett-Packard – from adopting a prediction market model to ascertain looming changes in their respective industries. Whether the subject is the potential global sales of video game titles, or the next Microsoft venture, this economic wunderkind is making big waves in big business.
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