Prediction Markets
Topic Owners: Matthew, Elisabeth
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Precis
Our seminar this week aims to discuss novel and/or controversial applications of prediction markets. Our study will be organized into three parts. First, before class everyone will get acquainted with prediction markets as they now exist and understand the basic economic theory behind their success--this page and the first required reading (the Wolfers/Zitzewitz article) will cover that background. We also tried a (failed!) experiment with creating our own prediction markets on intrade.net that inadvertently taught a lesson about how difficult it is to get efficient information markets (more below). Second, we will examine a few proposals for how prediction markets might be used at the frontier. The readings cover Professor Wolfers' crime prediction market, the DARPA project, and the Google Flu Tracker. In class, Professor Wolfers' will expand on the crime prediction market, and Bo Cowgill of Google will add some insight into Google's internal prediction markets. Third and finally, we will try to generalize from these examples some basic principles about what prediction markets can and cannot do well. At this point, we will consider skeptical arguments, both the set of (weak but popular) moral objections and more sophisticated practical/theoretical worries. Ultimately, the class will come to some conclusions about what types of uses prediction markets might have, perhaps inventing some ideas of our own.
I. What Prediction Markets Do Now
The most high-profile examples of prediction marketsthe Iowa Electronic Markets and Intradestarted by focusing primarily on predicting election outcomes and related political and financial events. Now they have expanded to cultural (Oscars) and technological (X Prize) events as well. The status of the commercial markets is uncertain; for example, Tradesports announced recently that it is closing. And questions remain about the legality of prediction markets, whether the CTFC will regulate them, and whether they will be taxed. The basic idea is that prediction markets are more accurate than experts or traditional public opinion polls, because among other advantages they require participants to offer predictions backed by some conviction (money) and because they aggregate knowledge held by many minds.
Several weeks ago the class started an experiment with its own prediction markets. Here was the plan: "Everyone will create their own prediction market contract via intrade.net. Once you set up an account there, you can then create you own contract at http://www.intrade.net/market/create/start.faces. Your contract can be about anything you like (doesn't have to be legal), but it should conclude before our class date, April 27, 2009. The idea is (1) for everyone to get a feel for how prediction markets operate; (2) to see what kinds of contracts get enough volume to be successful and what kinds don't; (3) to see how accurate the predictions are, how they change over time, etc.
"Once you've signed up and created a contract -- please do so by Friday, March 20 -- you can invite other people in the class to bet on your contract to give it some initial starting volume. (Intrade.net gives everyone $10k in play money upon signing up, so obviously if people want to bet on the wider world's contracts, that's great too). Everyone should list the contracts they've created below to facilitate class participation on intrade (and so that we can generate a variety of different kinds of contracts). At the actual class session on April 27, everyone should come in prepared to briefly discuss what happened with their contract (feel free to create more than one)."
The experiment was, like Apollo 13, a successful failure. The markets got no traffic, and the predictions did not move. There are several explanations for this result, some of which definitely played a role and some of which may have. First, intrade.net is a fake money site. The lack of a financial incentive is, of course, a substantial disincentive to would-be bettors. But this explanation cannot be sufficient, because the whole intrade.net site--not just our class-constructed markets--is based on the same fake money system. In fact, what is remarkable is how active and accurate some of the fake money markets are. Second, though, our markets were placed in the user-created market ghetto of the intrade.net site. Traffic there is generally lower than on the rest of the site, and activity is correspondingly reduced. Could this be an example of a coordination problem? Third, some of the topics chosen were obscure; an efficient market would need enough investors interested in the subject to get trading volume sufficiently high. Fourth, and probably most devastating, the betting mechanism only allows an up-down vote. This limitation takes away one of the essential comparative benefits of prediction markets over voting: it does not account for intensity of preference. The bettor who thinks the going rate is 1% off sends the same signal as the bettor who thinks the rate is 50% off. A well-designed prediction market would never be designed this way.
Required Reading for Part I
Justin Wolfers and Eric Zitzewitz | 18 Journal of Economic Perspectives 107 (2004) | (19 pages, essential background--only one equation for the math-phobic)
II. Novel Applications of Prediction Markets
More central to our purposes are increasingly prevalent proposals to use prediction markets to help guide law and policymaking. One of the earlier and more controversial applications was DARPA's planned terrorism futures market, which would have helped the Pentagon predict terrorist attacks, assassinations, and the like but was killed following political outcry. Somewhat less controversial are proposals to use prediction markets in areas with less potential for moral hazard. For example, some scholars have argued that they would be useful for corporate governance, for example as an alternative to disclosure requirements aimed at insider trading and other problems -- the idea is that prediction markets in which corporate insiders participated would provide the desirable information, at lower cost and greater accuracy. Professors Wolfers, Henderson, and Zitzewitz, in one of the required readings, describe how prediction markets might be useful to policymakers allocating resources to combat crime. Michael Abramowicz's recent book Predictocracy offers an extended analysis of the usefulness of prediction markets in law and decisionmaking by courts and legislatures (among other institutions).
Required Reading for Part II
Miguel Helft | New York Times | November 11, 2008 | (1 page, useful diagram)
M. Todd Henderson, Justin Wolfers, and Eric Zitzewitz | Olin Working Paper No. 402 | April 2008 | (5 pages, just read abstract and introduction)
Carl Hulse of the NYT and Wire Services | July 2003 | (~6 pages)
III. Skeptical Concerns
Required Reading for Part III
Discussion of the DARPA Markets in the Senate | July 28 and 29, 2003 | (2 short comments, mostly for humor value)
Student Note | 122 Harvard Law Review 1217 (2009) | (21 pages, a short but good overview of defenses and criticisms of prediction markets, especially as applied to law)
Optional Reading
- A brief paper describing the failed DARPA terrorism futures market, by a Professor at the Naval Postgraduate School. Robert Looney, DARPA’s Policy Analysis Market for Intelligence: Outside the Box or Off the Wall?, STRATEGIC INSIGHTS (2003).
- Professor Sunstein's Infotopia
- Robin Hanson's Futarchy proposal
- Cass R. Sunstein, Group Judgments: Statistical Means, Deliberation, and Information Markets, 80 N.Y.U. L. Rev. 962 (2005)
- Paper on the application of prediction markets to corporate governance
- Chapter 10 of Michael Abramowicz's book Predictocracy
Class-Constructed Markets
- Matthew: 2009 Virginia Attorney General Race
- CKennedy: A Million Chinese Charterists
Andrew: Will General Motors file for Chapter 11 by April 20, 2009? http://www.intrade.net/market/detail/?contractId=338028#GM_Files_for_Chapter_11_by_4/20/09%3F
- JG: A major world airline switches the default pilot for its flights over to computer (i.e. perhaps human copilot, but no human pilot) by 2020
- Gwen: I'm having trouble getting an account set up. Do you have to mail in a check? I get this error message when I try to use credit cards: "Unfortunately your bank has refused to authorise your deposit. Most US-based members are no longer able to fund their accounts by credit card due to the passage of recent legislation through the US Congress. Many non-US banks have also adopted a similar policy and will no longer authorise credit card transactions with certain classes of merchants. For more information about your attempted deposit please contact your bank. If you require assistance with funding your account by another method please e-mail us at help@intrade.com . We are happy to accept deposits by check, money order or bank transfer. Please see your My Account screen for more details." What law is this, and how recently did it change? [Elisabeth: Intrade.net is a free site -- you shouldn't have to use your credit card! You might be at the wrong site?]