September 28, 2004

Prediction Markets

Slog through the posts below because if you're interested in the potential power of prediction markets like the Iowa Electronic Markets these posts will help you understand some of the strengths and weaknesses of these devices.

• "On the Predictive Power of Markets"
  
• "The Predictions of Prediction Markets"
  
• "Candid Admission Time: What does TradeSports Tell Us?"
  
• "What Do IEM Prices Actually Mean?"
  
• "An Update on Manski, TradeSports and Predictive Markets"
  

While the Manski paper argues there is a weakness in the market-derived probability, Steve Vernon points out that the movement of the probability and the Manski bounds can tell us something about what market participants think will happen.

UPDATE: I just found this Tyler Cowen post. Here's a key paragraph:

The very virtue of prediction markets now becomes their cost. If you hear rumors, in the absence of prediction markets, you can ignore them and pretend they are not true. With asset markets, however, your forecast moves into equality with that of the market, otherwise you would trade. It is precisely this "forcing quality" that makes prediction markets so useful, but also so potent. Price movements are materially and psychologically harder to ignore. The very feature of prediction markets that mobilizes information also mobilizes coordinated social reactions to the embodied information, and not always for the better.

"Prediction Markets: Need We Fear Price Variance?"