The Wisdom of Public Prediction Markets

Posted on Thursday, September 4th, 02008 by Kevin Kelly
link Categories: Long Bets   chat 0 Comments

Prediction markets continue to proliferate. These communities use money to bet on outcomes in the future. If a prediction comes true, the winners reap the money from the losing betters. The price of a bet, or share, fluctuates over time — and thus can be used as a signal for the community’s opinion. In theory a prediction market taps into the “wisdom of crowds,” but can also be viewed as conventional wisdom. However the results of prediction markets have been proven to be reliable conventional wisdom. (See my previous post on the subject.)
There are two kinds of prediction markets: ones where you bet real money, and ones where you bet funny money. Since betting real money keeps people honest (to reduce their loses), markets with real money are considered a much better indicator of opinion than a mere poll — which has no “penalty” for being less than honest. But real money prediction markets are (stupidly) illegal in the US. So token markets like Long Bets and Bet2Give are devised to innovate around the law.
For instance, Hubdub trades token dollars. You are given $1,000 hubdubs at the start, and $20 each day you log on. You win or loose these token dollars on various predictions. There is a leaderboard which displays the highest ranked traders, showing how much they have gained in the last quarter. One fellow gained $1 million hubdubs, and now has a net worth of $3 million. Hubdub dollars are only good for bragging rights.
One clarification of how the price of a bet works (from Hubdub’s FAQ):

If a prediction has a yes value of 43%, does that mean that 43% of people have voted yes?
No, not really. The forecast is dependent on both the number of people who have selected this outcome and the amount they have risked on it. Very roughly, 43% means that 43% of the money risked by users is riding on that outcome.

I was curious how closely the two formats (real and token money) might match each other so I hunted for a bet that I thought most prediction markets might share: the outcome of the US presidential election. From my brief survey, betting real dollars and token dollars give similar results.  More so, there is a pretty close convergence of price among all the prediction markets:
Roughly, the day after Republican VP candidate Sarah Palin gave her rousing nomination speech, all six different prediction markets price Obama winning at about 60%.

Betfair, based in England, trades real money to make bets. It is the biggest prediction market in the world in terms of numbers of bettors and dollars bet. It’s bread and butter are sports events, including the Olympics, and card games, but it also runs bets on almost anything else including politics.
The day after VP candidate Sarah Palin’s nomination speach, Betfair bookies put the odds for Obama winning at 1.6  and give worse odds for McCain winning at 2.72.
Intrade also bets real money, also mostly on sports, but also on many other wagers. On this same day, Intrade money is on Obama winning at 59%.
On this same day Hubdub market rates on Obama win at 63%.

On this same day the Iowa Electronic Markets, which I’ve written about previously, and is the only prediction market in the US to legally use real dollars, has Obama winning at 59%.
Pres08 Wta
On this same day, Bet2Give also pegs Obama winning at 63 cents or 63%.

Bet2Give is run on Newsfuture software and is sort of a non-profit demo for Newsfutures, which sells software for customized enterprise-strength prediction markets. They promise that a company can “harness the wisdom of your crowds.” In Bet2Give you bet with real dollars but your winnings are given to charities, so technically you are not gambling.
Newsfutures itself runs a prediction market using token dollars. On this same day it shows a 60% chance of an Obama win.
PPX is another token market. Run by Popular Science magazine, it is their Prediction Exchange. It does not do political predictions, so there’s no chart or price for a new US president. Instead it focuses on tech and commercial predictions. Such as: Will Netflix top 10 million subscribers by end of 2008? (You need to register to see the wagers).
My conclusion is that token money prediction markets carry the same validity as real money prediction markets, and that they are fairly consistent across markets. In that sense they are probably reliable indicators of what people believe at this moment (not be confused with reliable predictions).

  • Interesting analysis. This corresponds to our experience at Hubdub. Our top traders weigh up their predictions as they would if they were real money. There is an excellent paper on this here:

  • Nigel refers to the standard article on the subject. My claim is that in arenas with lots of public information (football is one, national politics is another) the real money and play money markets are both going to reflect the larger consensus. If there are any backwater markets with few participants, anyone there who also pays attention to the larger consensus will adjust the local prices, so all markets will generally agree.

    The place where you might see a difference is in questions that aren’t of such widespread interest. We have seen in some of the play money markets (Foresight Exchange for example) that some people will occasionally spend significant effort researching a question for the esteem value alone. I would expect that real money would drive more research, but we have yet to see markets covering less universal questions where serious money is at stake.

  • Thank you Kevin:

    If you are a fan of Cass Sunstein and his remarkable “Infotopia” this is not new news. But there is another side to these markets: if as Sunstein, Surowiecki and others suggest predictive markets are remarkably accurate, why don’t Fox or the BBC or CNN or Wired refer to them more? Ever? Why Pew in a world in which, as Sunstein says, Hayek does seem to rule? Could it be that they are too accurate, too predictive? Could they make polling redundant? Just wondering?

  • Why is there still such skepticism about the reliability of prediction markets? The scientific literature about these things is extensive, easily available, and the record of success is undeniable, at least regarding elections, movies, sports, and all sorts of business-relevant forecasts. If, as we speak, major corporations around the world are running prediction markets, it is because they are finding business value in the process.

    Is the idea of human collective intelligence so uncomfortable? Do people subconsciously associate collective intelligence with insects, and therefore find it demeaning when the phenomenon is observed in humans? Shall we forever cling to the individual intellect as the epitome of intelligence just because each of us is so used to do his thinking with a single brain? The concept of human collective intelligence could prove as unsettling to western thought today as the ideas of Copernicus and Darwin in their times…

  • Though this article is two years older but I really admired what the reader is trying to get through. I believe sports betting is part of mans life and it was already in the system of having fun by looking at the game of chance.

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