The
Power of Prediction Markets
Prediction
markets can be uncannily accurate — sometimes. Scientists have begun to
understand why they work, and how they can fail.
Summary and Critique by Oddinigwe Onyemenem
Summary
In 2012, a group of international
psychologists embarked on a project dubbed the “Reproducibility Project” in an
effort to repeat dozens of psychology experiments to see which held up. One of
the participants, Ann Dreber, who leads a team of behavioral economists at the
Stockholm School of Economics, viewed it as an avenue to mix science with
gambling and thought it would be fantastic to bet on the outcome. The team was specifically interested to see whether scientists could make good use of
prediction markets: mini Wall Streets in which participants buy and sell
‘shares’ in a future event at a price that reflects their collective wisdom
about the chance of the event happening. As a control, Dreber and her
colleagues first asked a group of psychologists to estimate the odds of
replication for each study on the project’s list. Then the researchers set up a
prediction market for each study, and gave the same psychologists USD 100
apiece to invest. In 2015, the project had replicated fewer than half of the studies examined and Dreber found that
her experts hadn’t done much better than chance with their individual
predictions. But working collectively through the markets, they had correctly
guessed the outcome 71% of the time. According to Mann, experiments of this nature
depict the power of prediction markets to turn individuals’ guesses into
forecasts of sometimes startling accuracy.
Mann points out that prediction
markets are increasingly being used to make various kinds of forecasts such as
the outcomes of sporting events and business decisions. Prediction markets
advocates claim that it allows people to aggregate information without the
biases that affect traditional forecasting methods such as polls or expert
analysis. The application in science was shown by Dreber and her team by giving
researchers a fast and low-cost way to identify potential problems with
replicated studies. On the other hand, skeptics point out that prediction markets
are far from being perfect. This is due to an incorrect notion that a great
prediction is almost, always guaranteed when a market is set up. According to Eric
Zitzewitz, an economist at Dartmouth College, it is an area of active research
to determine the best designs for prediction markets and the limitations. Nevertheless,
advocates of prediction markets argue that even imperfect forecasts can be beneficial.
For instance, hearing there’s an 80 or 90% chance of rain can make an
individual take an umbrella.
The prediction-market idea was
revived by the spread of the Internet, which dramatically lowered the entry
barriers for creating and participating in prediction markets. In 1988, the
University of Iowa’s Tippie College of Business launched the not-for-profit Iowa
Electronics Market (IEM) as a network- based teaching and research tool. Over
the years, IEM has set up several markets to predict election outcomes which a
2008 study found that the its predictions across five presidential elections
were more accurate than the polls 74% of the time. The success of the IEM
helped to inspire the creation of dozens of other prediction markets.
The article also addresses the fact
that prediction markets have also missed the mark by a long shot in several
cases. In the Brexit case, the prediction market gave the odds of a stay vote
as 85% on the day of the referendum, whereas the outcome was narrowly in favor
to leave. Also, prediction markets were off the mark in predicting the outcome of
the 2016 US presidential election, which elected Donald Trump instead of the
highly-favored to win, Hillary Clinton. These sorts of instances have caused
academics to probe prediction markets about why they work so well, their limits
and reasons for failures? Mann points out that if prediction markets offer a
way to update guesses considering new information, they will do as well or
better than other forecasting methods. Prediction markets in general still need
to deal with challenges such as how to limit manipulation and overcome biases.
Critique
As rightly stated in the article,
prediction markets are used in a wide array of markets such as sports,
politics, movie, business, technology, etc. While some fully embrace it, others
remain highly skeptical due to the possibility of manipulation or infusion of
biases. Research into improving it still
needs to be done to ensure, as best as possible, the integrity of the process. In
the next decade, prediction markets can be a major driving force behind
significantly improving decision-making as more tools are implemented.
Source:
Posts
I share your concern that prediction markets in general still need to deal with challenges including manipulation and bias. The article addresses the fact that prediction markets have been inaccurate in several cases, specifically the 2016 US presidential election. Given the nature of prediction markets, traders are especially vulnerable to the bandwagon effect and following the wisdom of the crowd. With that being said, Do you think prediction markets are more or less accurate than the delphi method?
ReplyDeleteI think that prediction markets can really aide in identifying large moving players in an environment. I think that they can be similar to the beginner analysts that Professor Wheaton talked about. Yes nuance would help but even at a basic level I think that they can identify major moving points thus being pretty ok at forecasting.
ReplyDeleteI also agree there needs to be some nuance. What do you think would be some ways to cut the possible biases and add some nuance to the prediction markets?
ReplyDelete