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Prediction Markets: What Are They and How do They Work?
A valuable tool for executive decision making, lowering cost and increasing accuracy. Prediction markets are speculation hubs where traders predict future events such as election outcomes (Obama against McCain) or on economic outcomes, such as the US hit by recession or the Federal Reserve prediction and so on. The markets employ the “wisdom of crowds” theory to produce dynamic, probabilistic predictions combining the collective knowledge of many individuals who adopt different perspectives. They are beginning to be employed to obtain information about all kinds of events, from terrorist attacks to naturally occurring incidents such as flu epidemic. Individuals place bets on questions ranging from “Will the US enter recession in 2008?” to “Where will the next hurricane make landfall?” Some of the best online markets include the Lowa electronics markets, Yahoo tech buzz game and Public Gyan. In trade, run by trade exchange network, an Irish firm has earned $76 million of bets this year. Its data have reportedly being used by American commodities futures trading commission, the United States navy, various Federal Reserve banks, and the European central bank to forecast everything from elections to business successes and failures. CROWD WISDOM Prediction markets can be defined as agreements where individuals trade contracts, and payoffs are associated with efficient forecast of certain predetermined events in the future. These markets aggregate disparate pieces of information to produce market generate forecasts and have typical outperformed opinions. These were found to be more accurate than professional pollsters or market researchers. At the heart of these markets is the belief that it is the best method for aggregating opinions of large groups of people and come up with forecasts of events in the real world. Their principles is much like futures markets , where prices of contract is based on a collective day-to-day judgment either on a straight number, sales forecast, or a probability measured as a percentage. FROM GOOGLE TO THE US ELECTIONS Today, prediction markets have moved from general election predictions to other industries like retailing, consumer packaged foods, hotels, healthcare, steelmaking and telecommunications. In the last four years, dozens of major corporations began experimenting with prediction markets to try to reduce risk and accelerate innovation by tapping into the collective wisdom of the workforce. The companies which have joined the club includes Cisco Systems, Microsoft, General mills, Arcelor Mittal, HP, Yahoo and many more. They have also been applied to predict Fed policy action, leading economic indicators, stock prices etc. at the same time, a network of software and service-suppliers like Consensus point and News futures has been working on techniques and software to help companies set up predictions markets. CHALLENGES REMAIN One of the most inherent dangers for prediction markets is they are subject to manipulation and speculative moves by interested parties. This was even a great concern in internal corporate markets; the organizers at Google were increasingly concerned about the possibility of market manipulation by average employees and senior management. Manipulation is an important challenge because the potential returns far outweigh the financial losses. Also, it has been observed that the information collected about future events have the influence to shape the decision about real world outcomes. For instance, in the case of political prediction markets, voters do not extend their support for candidate who is faring poorly. While the market significantly outperform the long run forecasting tools like polls in predicting events, deceptive tactics such as bluffing and reticence cloud their accuracy. Bluffing about information defeats the purpose of this market. There have also been circumstances when reticence has benefitted traders. Expert’s solution to such dishonest tactics is to impose a penalty on such trade by charging the participant. Further there is a tough organizational challenge for the markets to take off, since the concept behind the markets, counteracts some of the basic parameters such as expertise, knowledge and the way organizations should work. Although, it is just combining the collective wisdom of participants, many people have big questions about them, despite the evidence that they work well. The success of prediction markets depends on the involvement of informed, diverse individuals. The quality and quantity of participation is another factor hard to ignore. The markets would be unsuccessful even if well-informed individuals with insufficient access to the right data make poor predictions. Individual’s geography and organizational proximity, i.e., working for the same managers, also play an important role in influencing decisions. Participants who worked alongside one another with shared interest would tend to be similar. The ability of the markets to aggregate information broadens the accessibility to sensitive information. Since companies are cautious about reveling their sensitive information, they are now announcing certain time periods as safe for the employees to trade, such as after the annual report release. TIME TO ACT Smartly applied, the information gleaned from prediction markets help managements listens to the voices in the company that might otherwise go unheard. An important initiative towards encouraging prediction markets deliver on their promise is to clear some of the regulatory barriers concerning them. Experts say that the US commodities trading commission (CFTC) waivers would clear their legal status and stimulate innovation in both the design and use of event prediction markets. Waivers should be granted only to not for profit research institutions such as universities and think tanks; Government research agencies; and private business and non profits operating in the market for research purposes. Clear questions, short term evaluations and a deep pool of traders would make them more functional. Also, new federal rules are desirable to encourage prediction markets so that they can be developed as innovative planning tools. Also, if the market mechanics are not clear, there is a possibility of losing a potential trader. Thus, companies like Google have initiated a step by step presentation for groups to make them familiar with prediction markets. Bo Cowgill, analytics specialist, Google, says “Prediction markets could make everyone in the company an insider from the SEC perspective, if you do not manage it well” thus, companies like Google do not use prediction markets to forecast revenue. PREDCITING FOR SUCCESS Prediction markets have generated a great interest in recent years as they react extremely quickly to news. This enables participants to obtain an immediate idea of breaking events. It has been reported that they were 70% more accurate than the company’s traditional forecast models. Now they are increasing under intense research in various fields ranging from economics to political science to computer science. In denouncing prediction markets as wrong, many miss the logic that they are a useful window, providing the guess of a group as to the probability of occurrence of future events. A long hard road must be traversed in identifying new ideas to develop prediction markets.
>> Read more articles written by Chillibreeze writers:1. Articles related to Content and Outsourcing
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