From Ring Knockouts to Court Deliberations: How Markets Predict

Apr 1st, 2012 | Filed under: Today's Post | By:
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A prediction market is, by standard definition, a market that exists for the primary purpose of making predictions about a future event. In fact, though, any market can be employed to make predictions. If I know that the odds makers for an upcoming heavyweight championship fight are laying odds 1: 2 in favor of the reigning champ, then I can declare that the markets have ‘predicted’ his victory.

In the boxing-match case, prediction is a collateral consequence. The mechanism that creates those odds doesn’t exist to predict, it exists to keep the bets flowing, by creating as much demand for the challenger’s side of the proposition as there is for the champ’s side. If too many gamblers/voters favor the champ, even if for sentimental home-town-boy reasons, the odds will end up skewed in his favor. (The odds makers and their employers won’t be at all put out by that predictive failure.)

To get somewhat closer to a true prediction market (though not quite there) one can point to the Saddam Security. This was a market established by a sports-betting operation prior to the Iraq War that allowed for wagers on whether Saddam Hussein would still be the President of Iraq by a given date. If you were fully (100 percent) confident that Saddam would be deposed by a certain date, you might rationally have bet as high as $9.99 for each $10 incremental payout on his deposition and still secure a profit – assuming away transaction costs and the house’s take. If you thought it only 50 percent likely that his deposition would take place by a certain date, it would not have been rational for you to pay more than $5 for the prospect of a $10 payout. In this way, the Saddam Security market aggregated opinions – not any old shooting-the-mouth-off opinions, but the opinions of those who were willing to risk their money thereon.

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Author Bio:
Christopher Faille is a Jamesian pragmatist. William James has taught him, for example, that "you can say of a line that it runs east, or you can say that it runs west, and the line per se accepts both descriptions without rebelling at the inconsistency."

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