Introduction to Prediction Markets

An Introduction to Prediction Markets (a.k.a. Idea Futures, Decision Markets,

Information Markets, and Event Markets)

alex kirtland / UsableMarkets25 Mar 2007

www.usableMarkets.com

Simple Definition of Prediction Markets

• A place where information is aggregated via market (or other) mechanisms for the primary purpose of forecasting events, or the probability that an event will occur


outcome / contract

outcome / contract

outcome / contract

outcome / contract

outcome / contractAll Others

The “who will win the 2008 presidential election” market

the market (the event)


Contract Hillary:

Hillary Clinton WILL BE our next president

$0.00 $1.00Price

0% 100%Prediction

$0.26

26%

Hillary Clinton has a 26% chance, at this point in time, of being our next president.


All Others

The “who will win the 2008 presidential election” market

the market

$0.26 $0.20 $0.18 $0.12 $0.24

26% 20% 18% 12% 24%

= 100%



Basic Elements of a Prediction Market

1. The Market - Markets are generally created around a specific topic or event, and contain the contracts which are traded. Examples: The “Who will win the 2008 Presidential Election” Market

2. The Contract – A specific prediction that the trader can buy or sellExamples: Hillary Clinton

Binary contract pays out all (e.g. $1.00) or nothing (e.g. $0.00) Linear contract pays out based on final value

3. Trading Platform – The way that someone interacts with the market

Double Auction / Book Order System Automated Market Maker


Basic Elements of a Prediction Market, cont.

4. Traders – the people who come to a market and participate by buying and selling

Marginal traders – knowledgeable traders Noise traders – traders who are not knowledgeable, or have

some motivation for trading other than what they think the true price should be.

5. Liquidity – the number of trades

6. Currency –real money or fake money.


Simple Definition of Prediction Markets

• A place where information is aggregated via market (or other) mechanisms for the primary purpose of forecasting events, or the probability that an event will occur

• Why?– Wisdom of the Crowds – “Under the right conditions groups can be

remarkably intelligent and possibly smarter than the smartest person.” James Surowiecki

– Markets provide incentives for information discovery and truthful revelation of beliefs

– Efficient Market Hypothesis – all available information incorporated into the price


How are prediction markets

different than polls?


Who uses these things?

?






www.usableMarkets.comand others ....




Gamers

Gamblers

Sophisticates

Employees

Your “Average Joe”


Knows how to trade

Doesn’t



Most of us

Knows how to trade

Doesn’t







Where are we now?

• No perfect site, but lots of experimentation

• Industry• Corporate

• A growth industry ...?


Q&A

Questions I haven’t answered yet ...


Special Thanks To ...

• Emile Servan-Schreiber (newsFutures)• Ed Lenox (TradeSports)• Robert Wilburn (RimDex)• Adam Siegel (InklingMarkets)• Jed Christiansen (Mercury Research & Consulting) • Bo Cowgill (Google)• David Pennock (Yahoo)• Dave Perry (Consensus Point)• Midas Oracle / Chris Masse (Blog)

Thank You!

Business

Introduction to Prediction Markets