Tyler Cowen (reference below, video on right), describes prediction markets, markets that have been designed so prices can be interpreted as probabilities and used to make predictions.
Cowen notes that normal markets can be useful predictors of the future because prices are signals that convey information about goods. A classic example is using the futures market for orange juice to predict Florida weather. But such prices are imperfect predictors as there are many factors that influence the price.
Prediction markets are specifically designed for the purpose of predictions. Cowen reviews two well-known prediction markets:
- Iowa Electronic Markets (at http://tippie.uiowa.edu/iem/, accessed 1 May 2016) where traders buy and sell shares in candidates, and the price predicts electoral results
- Hollywood Stock Exchange, (at http://www.hsx.com/, accessed 1 May 2016) that predicts commercial success of films through the actions of traders buying and selling shares and options in movies and music.
Cowen notes such markets attract many experts. In the case of the Iowa Electronic Markets, experts are using real money and it is not surprising that in over 20 years it has turned out to be a better predictor of the outcomes than polls.
The Hollywood Stock Exchange uses pretend money but the participants take it sufficiently seriously that the it has been a reasonably good predictor of commercial success:
From http://www.mruniversity.com/node/192290, accessed 1 May 2016.
- You manage a department store in Florida, and one winter you read in the newspaper that orange juice futures have fallen dramatically in price. Should your store stock up on more sweaters than usual, or should your store stock up on more Bermuda shorts?
Atlas topic, subject, and course
Tyler Cowen, Prediction Markets (9-minute video), Principles of Economics – Microeconomics, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/prediction-markets-election-forecasting, accessed 1 May 2016.
Page created by: Ian Clark, last modified 1 May 2016.
Image: Tyler Cowen, minute 0.12 of Tyler Cowen, Prediction Markets (9-minute video), Principles of Economics – Microeconomics, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/prediction-markets-election-forecasting, accessed 1 May 2016.