What is moving in the prediction markets?

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A number of financial markets let investors make predictions about future price and risk developments: for example, those who buy a stock think the price will rise.

There are also “futures” markets, which allow someone to promise to deliver a certain item at a certain price on a certain date in the future. Some futures markets are based on financial prices such as the Standard & Poor’s stock market index price; others are based on the prices of physical items like oil, gold, wheat, soybeans, and many more.

When economists refer to a “prediction market” they are thinking of a market where instead of buying and selling based on expectations of future prices, buying and selling occurs based on expectations. future events. One of the best known examples is the Iowa Electronic Markets, where you can place small bets on the results of elections and related events. The rise or fall of prices in that market can then be used as a measure of the likelihood of who will be elected.

But in the early 2000s, the idea of ​​generalizing the use of prediction markets took a serious hit in public relations. Justin Wolfers and Eric Zitzewitz tell the story in their article “Prediction Markets” in the Spring 2004 issue Economic Outlook Journal (where I work as an editor). They wrote:

In July 2003, news articles began to surface about a project within the Defense Advanced Research Projects Agency (DARPA), a research think tank within the Department of Defense, aimed at establishing a market for policy analysis that would allow negotiation of various forms of geopolitical risk. The contracts offered were based on indices of economic health, civilian stability, military readiness, indicators of conflict and potentially even specific events. For example, the contracts could have been based on questions such as “How fast will Egypt’s non-oil production increase next year?” Or “Will the US military withdraw from Country A in two years or less?” Moreover, the exchange would have offered combinations of contracts, possibly combining an economic event and a political event. The concept was to find out whether the negotiation of such contracts could help predict future events and how the links between the events were perceived. However, a political outcry ensued. Critics savagely slammed DARPA for proposing “Futures of Terrorism”, and rather than spending political capital to defend a small program, the proposal was dropped.

After this experience, while the prediction markets continued to exist, they were mostly in small and limited forms. For example, Iowa’s electronics markets are small as an experimental market designed specifically for research and educational purposes. It has become quite common for large companies like Google and Ford to manage “internal” prediction markets, where company members can bet on issues such as meeting project deadlines or sales targets; it often turns out that feedback from the internal market is a useful corrective to managers’ promises that all is well. The Hollywood Stock Exchange allows you to bet on the total sales of a film in the weeks following its release. Of course, Americans can also bet on various outcomes using better markets in other countries or just look at those markets to see what messages they are sending.

But now there are turmoils that the US prediction markets have never completely gone away and may be poised to rise again. Mary Brooks and Paul Rosenzweig tell the story in “Bet on the Next Big Political Crisis – No, Really” (Lawfare Blog, July 13, 2021). They report new academic experimentation beyond Iowa’s long-standing electronics markets:

More recently, Georgetown University has built its own crowd forecasting platform – which is not strictly a prediction market but rather a means of probing and pooling expert opinions – specifically for geopolitical future. Likewise, Metaculus provides a platform for a near-prediction marketplace, in which the currency of exchange is prestige points, and anyone can submit a question for inclusion in the market.

They point out that the use of internal corporate prediction markets has increased, and that indeed, there is a market for those with top-secret clearance in the U.S. intelligence community:

[T]there is a significant demand for internal markets for corporate forecasting and crowd forecasting. Google, Ford, Yahoo, Hewlett-Packard, Eli Lilly and a number of other major companies have operated or continue to operate an enterprise marketplace. Some of their questions can delve into geopolitics, but in most cases employees are betting on things like meeting deadlines, products that will take off, and tax returns. …

For example, in 2010, the intelligence community launched a prediction market for top-secret government employees on its classified networks. From 2011 to 2015, the Intelligence Advanced Research Projects Activity (IARPA) – the intelligence-focused sister of DARPA – executed the Aggregative Contingent Estimate (ACE). ACE was a project designed to “dramatically improve the accuracy, precision and timeliness of intelligence forecasts … [by means of] techniques that elicit, balance and combine the judgments of many intelligence analysts. Today, IARPA still runs the Hybrid Forecasting Competition, which “develops[s] and test[s] hybrid geopolitical forecasting systems.

But perhaps most interestingly, there is now a company called Kalshi, approved by US government regulators, which will allow negotiation on the outcome of events. Brooks and Rosenzeweig write:

Last week, a prediction market that functions like a real financial market opened its digital doors. Kalshi, a San Francisco-based startup currently operating in beta, is the first fully regulated (CFTC-approved) prediction marketplace. Because Kalshi is regulated, larger amounts of money can be wagered than in many other markets, allowing them to build a new asset class of futures events. The implications are obvious: such an asset class could serve as an alternative or complement to more traditional insurance, allowing businesses and individuals to cover themselves against crop failures, cyber attacks or floods.

It is of course easy to raise concerns about prediction markets. Will they allow certain people to benefit from an unpleasant event? Yes, but the same goes for a number of completely legal investments that can be made in other financial markets (such as those linked to the stock prices of insurance companies). Can they be played by investors? While a group of investors can certainly drive the price up one way or another, the ultimate question is whether or not the event actually happens. Those looking to push the prediction market price to strange places must be prepared to lose money.

No one is saying that the market prediction is perfect: in sports betting, for example, the favorite does not always win. But prediction markets offer a way to bring together the information and beliefs of a wide variety of people, rather than relying on other flawed prediction methods like listening to internal experts, external experts, or data from outside. survey. If you think the probability of a future event embodied in the prediction market prices is wrong, that’s fine; are you ready to back your belief with real money? If you feel uncomfortable doing this, perhaps you should reconsider how strongly you hold that belief.


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