Prediction Markets Outline What is the probability that Barack Obama wins the election What is the probability that Barack Obama wins the election What is the probability that Barack Obama wins the election
Michelman, Kate, Contributing Columnist has reference to this Academic Journal, PHwiki organized this Journal Prediction Markets J. Berg, R. Forsythe, F. Nelson in addition to T. Rietz, Results from a Dozen Years of Election Futures Markets Research, 2001. B. Cowgill, J. Wolfers, in addition to E. Zitwewitz. Using Prediction Markets to Track In as long as mation Flows: Evidence from Google. 2008. Outline Introduction to prediction markets Empirical Paper Paper on Google in addition to In as long as mation Flows Current prediction markets What is the probability that Barack Obama wins the election
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What is the probability that Barack Obama wins the election Polls Electoral college Changes be as long as e election day Bias Pundits Cheap Talk Problem Forecasting Individual context What is the probability that Barack Obama wins the election New solution: Prediction Markets A financial futures market where money is exchanged based on the outcome Winner Takes All (WTA) Market Contract has payoff of $0 or $1 based on outcome Assumption: event has a clear outcome Obama Wins Probability = p Obama Loses Probability=1-p Payoff=$1 Payoff=$0
Winner Takes All (WTA) Market X is the payoff P is the probability of the outcome occurring Let the market price of a share equal c E(X)=p p 1-p X=1 X=0 Winner Takes All (WTA) Market Expected Profit as long as buyer: Profit = Payoff Cost E(Profit) = E(X)-c E(Profit) = p-c Multiple, exhaustive markets summing to 1 (no arbitrage) Assuming no risk aversion, expected returns should be equivalent in each of these markets P=c The market price is the perceived probability of the event occurring Vote Share Market Contract pays $1X, where X is the vote share of a c in addition to idate For example, the Bush contract in 2004 would have paid $50.70 (Bush won 50.7% of the vote) Bidders auction on contract By similar logic as be as long as e, C=E(X) The market price is the expected vote share
Other Market Types Can be used to determine entire probability distributions For example, a contract can pay off the square of the vote share Market price= E(X^2) Solve as long as variance Other Market Types Can be used to determine joint distributions For example, a series of contracts can trade based on the probability of two events occurring Market 1: Probability of Troop Withdrawal by 2010 Market 2: Probability of Obama Winning Market 3: Probability of Troop Withdrawal by 2010 AND Obama Wins Solve as long as P(Troop Withdrawal Obama Victory) Paper 1 J. Berg, R. Forsythe, F. Nelson in addition to T. Rietz, Results from a Dozen Years of Election Futures Markets Research, 2001.
Introduction Are prediction markets accurate When do prediction markets work Methodology Ran study on IEM Continuous double auction market open 24 hours per day Vote share or seat share market Traders are overwhelmingly, male, well-educated, high income, in addition to young Are Prediction Markets Accurate
Are Prediction Markets Accurate Benchmark: Polls Short-term, prediction markets are at least as good as polls Compared price at midnight on night be as long as e election with last day polls Average prediction market error=1.49% Average poll error=1.93% Are Prediction Markets Accurate Are Prediction Markets Accurate Long-term, prediction markets are superior to polls No empirical methodology given as long as this assertion Example from 1996 as worst per as long as ming short-term prediction, yet relatively stable long-term prediction
Are Prediction Markets Accurate When do prediction markets work Necessary criteria Enough traders so that the aggregate of their knowledge can as long as ecast correctly the outcome of the election. Effective market mechanism as long as revealing collective in as long as mation Markets per as long as m better when: More active participants Fewer contracts When do prediction markets work Individual Bias Most traders in a market are heavily biased Often vote as long as what they WANT, versus what is LIKELY Marginal traders empirically tend to be much less biased Marginal traders set prices, not average traders In as long as mation Traders have many sources of in as long as mation Polls, past results, analysis, etc.
Conclusion Under reasonable criteria, prediction markets are effective Paper 2 B. Cowgill, J. Wolfers, in addition to E. Zitwewitz. Using Prediction Markets to Track In as long as mation Flows: Evidence from Google. 2008. Introduction Uses internal prediction market at Google Examines efficiency of the market Conclusion: Relatively efficient with persistent biases Observes demographic in addition to location in as long as mation on traders in addition to studies the trends Conclusion: location matters
Googles Prediction Market Internal WTA market as long as Google employees only 1,463 employees participated (about 15% at the time) in 25-30 markets Not a r in addition to om sample Trades were about: Google-related events (release dates, sales targets) Fun markets: not Google related Trades took place in Goobles, which could convert into raffle tickets as long as prizes Differences to Consider Public vs. Private Inside in as long as mation Real money vs. Fake money Do the incentives line up Favorite Bias Outcomes that are likely to occur are overpriced Counter-intuitive: in presence of liquidity constraints, greater risk can be taken in long-shots versus favorites Methodology: break all contracts into 20 bins based on price, in addition to calculate probability as long as events in that bin. Biases: The Efficiency of Googles Markets
Biases: The Efficiency of Googles Markets Extreme Aversion Traders misjudge very small probabilities Counteracts favorite bias at extremes Also present in Intrade in addition to larger markets Biases: The Efficiency of Googles Markets Short Aversion Traders prefer to hold long positions versus short positions Evidence: more arbitrage opportunities exist where trades sum to more than one than less than one Biases: The Efficiency of Googles Markets
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