Money Talks

Prediction markets work

The future may be unknowable, but you can always guess. And thanks to prediction markets, your guesses, in conjunction with the guesses of others, can beat predictions made by professional forecasters. 

Just as money creates incentives in other realms of the economy, putting money or other stakes on guesses encourages better guesses. Hence the development of “prediction markets,” where people bet money—sometimes real, sometimes fake—on specific future outcomes. 

In a new study from the National Bureau of Economic Research, economists Erik Snowberg of Caltech, Justin Wolfers of the Wharton School, and Eric Zitzewitz of Dartmouth conclude that prediction markets “out-perform both professional forecasters and polls in a variety of statistical tests.” They say a hardy prediction market needs certain conditions to flourish, including a well-defined question about which there is dispersed information and a small likelihood of traders with specific inside information. 

Corporations such as Microsoft and Hewlett-Packard, Snowberg et al. note, are using markets internally to “potentially pass unbiased information from company’s front-line employees to senior management” and to create “idea markets” to help shape research budgets. More intelligent use of prediction markets could lead to better forecasting of the effects of both elections and wars, the authors conclude. They say an uncertain legal and regulatory environment makes prediction markets less widely and innovatively used than they might be.  

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