Prediction markets

Crowd–based speculation technique to assess probable future outcomes. Prediction Markets, sometimes referred to as “information markets,” “idea futures”, or “event futures”, are markets where participants trade contracts whose payoffs are tied to a future event, thereby yielding prices that can be interpreted as market-aggregated forecasts. Much of the enthusiasm for prediction markets derives from the efficient markets hypothesis. There are important but subtle differences between the market’s median expectation and the median expectation of market participants. Betting has probably been part of society’s way of dealing with uncertain futures since money and history began; prediction markets simply organize these activities into precise and generally interesting questions about future uncertainties. There are three main types of contracts: 1. In a “winner-take-all” contract, the price represents the market’s expectation of the probability that an event will occur (assuming risk neutrality). 2. In an “index” contract, the amount that the contract pays varies in a continuous way based on a number that rises or falls, like the percentage of the vote received by a candidate. The price for such a contract represents the mean value that the market assigns to the outcome. 3. In “spread” betting, traders differentiate themselves by bidding on the cutoff that determines whether an event occurs. 4.Prediction markets seem to display some of the deviations from perfect rationality that appear in other financial markets. There is substantial evidence from psychology and economics suggesting that people tend to overvalue small probabilities and undervalue near certainties. Another behavioral bias reflects the tendency of market participants to trade according to their desires, rather than objective probability assessments. A further possible limitation of prediction market pricing arises if speculative bubbles drive prices away from likely outcomes